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  • Retirement Planning in a Low Interest Rate Environment

    I was perusing the always excellent Oblivious Investor today and came across a link to a post by Chris Mamula on the implications of the low interest rates on bonds. Here is the link. https://www.caniretireyet.com/retiri...nterest-rates/ I have been thinking about this because I am notionally inside a three year window to retire. Unfortunately, while the questions asked in the post are good, I’m not sure the answers are as helpful. But just thinking it through, I’m torn between holding bonds as a risk reduction strategy for stocks despite their poor interest rate returns, and putting the money to some use that necessarily raises risk. I’ll probably do some of both. That is, bonds will serve to buffer stocks, but I’ll look for other income generating investments as well and divert some of the bond allocation there if I can control risk.

    One obvious choice is real estate. I recently paid off the mortgage on a rental property And now own two free and clear. I really did not want to start generating that income for another few years, but the mortgage was quite high so this looked like a relatively risk less way to generate returns given I already owned the properties. But it was also a minor move relative to the 35% of my portfolio that is in bonds (vanguard total bond market and intermediate term tax exempt). And I am not sure I want to add to my real estate portfolio at this point. (Syndications and funds might be a play.) Anyone have other good ideas to offer to generate income in retirement as a substitute for bonds?

  • #2
    Bonds and cash are for liquidity. As you know, I believe they are inappropriately used as investment "buffers". The only way to know how much to hold, however, is in the context of a financial plan.

    One of our clients is approaching retirement and wants to hold 50% of funds in cash and bonds. This couple can afford to do so. The important point, though, is to understand the purpose of liquidity v investing. They can invest 50% in an appropriately-diversified equity fund portfolio and keep 50% liquid and live happily ever after. But bonds are not investments, although they are repackaged in funds and sold as such. They are debt to be repaid at a time certain. If they don't return more interest than a HYSA, then a HYSA is better. And I think they'll gradually change the proportions but, for now, we know they'll be just fine with that and be able to sleep at night.
    Our passion is protecting clients and others from predatory and ignorant advisors. Fox & Co CPAs, Fox & Co Wealth Mgmt. 270-247-6087

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    • #3
      Clements is abandoning bonds which is a big deal: https://humbledollar.com/2020/06/farewell-yield/

      But if you're heading into retirement you need liquidity, I think I heard Suze Orman say you need at least 3 years of liquidity.

      This was interesting: Fidelity says 18% of investors sold out of all their stocks during the last few months, and a third of investors over 65 years old.
      It's psychosomatic. You need a lobotomy, I'll get a saw.

      Comment


      • #4
        Originally posted by jfoxcpacfp View Post
        But bonds are not investments, although they are repackaged in funds and sold as such. They are debt to be repaid at a time certain. If they don't return more interest than a HYSA, then a HYSA is better.
        I disagree with this point. Though as you state bonds are a agreement for repayment, there are many types of risks inherent in bonds that would be construed as an 'investment' such as company/ sovereign, currency, duration, liquidity, and of course interest rates. Couple the differing types of risks with structure possibilities within bonds such as convertibles, preferred, etc. Yes a bond differs from an equity, though bonds are IMO an investment also.

        I am taking your advice to have I believe 5 years of living expenses available in early retirement. 20/80 equity (low risk equity fund) and bond split and hopefully contributing enough have this fully funded by the time we retire.

        Comment


        • #5
          Originally posted by jfoxcpacfp View Post
          Bonds and cash are for liquidity. As you know, I believe they are inappropriately used as investment "buffers". The only way to know how much to hold, however, is in the context of a financial plan.

          One of our clients is approaching retirement and wants to hold 50% of funds in cash and bonds. This couple can afford to do so. The important point, though, is to understand the purpose of liquidity v investing. They can invest 50% in an appropriately-diversified equity fund portfolio and keep 50% liquid and live happily ever after. But bonds are not investments, although they are repackaged in funds and sold as such. They are debt to be repaid at a time certain. If they don't return more interest than a HYSA, then a HYSA is better. And I think they'll gradually change the proportions but, for now, we know they'll be just fine with that and be able to sleep at night.
          Definition of investment

          (Entry 1 of 2)

          : the outlay of money usually for income or profit : capital outlay
          Erstwhile Dance Theatre of Dayton performer cum bellhop. Carried (many) bags for a lovely and gracious 59 yo Cyd Charisse. (RIP) Hosted epic company parties after Friday night rehearsals.

          Comment


          • #6
            Originally posted by Larry Ragman View Post
            I was perusing the always excellent Oblivious Investor today and came across a link to a post by Chris Mamula on the implications of the low interest rates on bonds. Here is the link. https://www.caniretireyet.com/retiri...nterest-rates/ I have been thinking about this because I am notionally inside a three year window to retire. Unfortunately, while the questions asked in the post are good, I’m not sure the answers are as helpful. But just thinking it through, I’m torn between holding bonds as a risk reduction strategy for stocks despite their poor interest rate returns, and putting the money to some use that necessarily raises risk. I’ll probably do some of both. That is, bonds will serve to buffer stocks, but I’ll look for other income generating investments as well and divert some of the bond allocation there if I can control risk.

            One obvious choice is real estate. I recently paid off the mortgage on a rental property And now own two free and clear. I really did not want to start generating that income for another few years, but the mortgage was quite high so this looked like a relatively risk less way to generate returns given I already owned the properties. But it was also a minor move relative to the 35% of my portfolio that is in bonds (vanguard total bond market and intermediate term tax exempt). And I am not sure I want to add to my real estate portfolio at this point. (Syndications and funds might be a play.) Anyone have other good ideas to offer to generate income in retirement as a substitute for bonds?
            There isn't any free lunch. Interest rates are historically low, and there are no easy options to improve returns.

            TIPS offer negative real rates all the way out to 30 years: https://www.treasury.gov/resource-ce...data=realyield

            There is a reason for that; there are no "good" opportunities relative to historical figures.

            Many developed countries are paying negative nominal rates at this point. That was well known to be impossible up until a few years ago, when suddenly the impossible became reality.

            Nominal US treasurys (yields still positive so far) will be helpful in a deflationary environment and I have 10-13% of my portfolio in LT treasurys in case this occurs (but I bought these as 30-yr bonds around 2013-2014 when interest rates were 4% to 4.7%). If that doesn't occur, I'll probably earn a negative real return from here.

            Bonds aren't for dreamers, but there are plenty of people who think that they will earn 7% real in stocks because that was the average over some historical period. That isn't going to happen, not over the long term, but stocks are suitable for dreamers.

            The most rational estimates of the equity risk premium suggest it is smaller than realized in most historical periods, not larger. US stocks have higher estimated prospective returns than bonds, but I don't expect much more over the next 10-20 years, and it isn't a sure thing -- just the most likely outcome.

            Equity valuations abroad are lower despite the generally lower interest rates in most of the rest of the world, and the dollar is reasonably strong now. That is your best chance for better passive LT returns.

            You may do better with a private business (e.g., rental properties, franchise operations, etc.), but that is more work and more concentrated risk.

            My solution is to save more and work longer.
            Erstwhile Dance Theatre of Dayton performer cum bellhop. Carried (many) bags for a lovely and gracious 59 yo Cyd Charisse. (RIP) Hosted epic company parties after Friday night rehearsals.

            Comment


            • #7
              Originally posted by CM View Post

              There isn't any free lunch. Interest rates are historically low, and there are no easy options to improve returns.

              TIPS offer negative real rates all the way out to 30 years: https://www.treasury.gov/resource-ce...data=realyield

              There is a reason for that; there are no "good" opportunities relative to historical figures.

              Many developed countries are paying negative nominal rates at this point. That was well known to be impossible up until a few years ago, when suddenly the impossible became reality.

              Nominal US treasurys (yields still positive so far) will be helpful in a deflationary environment and I have 10-13% of my portfolio in LT treasurys in case this occurs (but I bought these as 30-yr bonds around 2013-2014 when interest rates were 4% to 4.7%). If that doesn't occur, I'll probably earn a negative real return from here.

              Bonds aren't for dreamers, but there are plenty of people who think that they will earn 7% real in stocks because that was the average over some historical period. That isn't going to happen, not over the long term, but stocks are suitable for dreamers.

              The most rational estimates of the equity risk premium suggest it is smaller than realized in most historical periods, not larger. US stocks have higher estimated prospective returns than bonds, but I don't expect much more over the next 10-20 years, and it isn't a sure thing -- just the most likely outcome.

              Equity valuations abroad are lower despite the generally lower interest rates in most of the rest of the world, and the dollar is reasonably strong now. That is your best chance for better passive LT returns.

              You may do better with a private business (e.g., rental properties, franchise operations, etc.), but that is more work and more concentrated risk.

              My solution is to save more and work longer.
              Stocks will remain a cornerstone. Probably will not get into franchises, but I may buy more real estate. We have a reasonable system there. Working longer and saving more is clearly another logical choice. Steady stream of income goes a long way to alleviating low returns. I have actually considered a glide path by slowing down at work in a few years. I don’t think it will be necessary, but it would be useful since there are a few things I would like to finish up up outside my full time responsibilities. But I definitely want to be in the position to only do what I want during this period, for which which FI will be helpful.

              Comment


              • #8
                I've written about this sort of thing (low prospective returns) many times in this forum. Here is Howard Marks (renowned investor, largely in distressed debt) on the why of low prospective returns:

                (See third page, the 4 offset points.)

                https://www.oaktreecapital.com/docs/...of-a-rally.pdf
                Erstwhile Dance Theatre of Dayton performer cum bellhop. Carried (many) bags for a lovely and gracious 59 yo Cyd Charisse. (RIP) Hosted epic company parties after Friday night rehearsals.

                Comment


                • #9
                  Originally posted by CM View Post
                  Definition of investment

                  (Entry 1 of 2)

                  : the outlay of money usually for income or profit : capital outlay
                  Yes, but (I believe) “income” in this context is used as a synonym for profit, which is typical of the syntax of dictionary definitions. If there is a 2nd meaning (i.e. interest instead of profit), it w/h/b listed in a 2nd bullet point.

                  I don’t consider a family loan or an interest-bearing account to be an investment, either. But I’m just passing along our definition when working with our clients - helps us to be consistent to keep liquidity and investments separate and have a clean separation. Otherwise, cash would be a “poor” investment if we considered it an investment.
                  Our passion is protecting clients and others from predatory and ignorant advisors. Fox & Co CPAs, Fox & Co Wealth Mgmt. 270-247-6087

                  Comment


                  • #10
                    Originally posted by jfoxcpacfp View Post

                    Yes, but (I believe) “income” in this context is used as a synonym for profit, which is typical of the syntax of dictionary definitions. If there is a 2nd meaning (i.e. interest instead of profit), it w/h/b listed in a 2nd bullet point.

                    I don’t consider a family loan or an interest-bearing account to be an investment, either. But I’m just passing along our definition when working with our clients - helps us to be consistent to keep liquidity and investments separate and have a clean separation. Otherwise, cash would be a “poor” investment if we considered it an investment.
                    I suppose you can define words in any way you like as long as everyone involved understands the new meaning, but bonds are clearly an investment.

                    Different investments have different risk characteristics and different expected and realized returns, and stocks should provide more return than bonds given the relative uncertainty of those returns. I imagine that is why you call stocks an investment and decide that bonds don't qualify.

                    However, bonds apparently outperformed stocks for 68 years between 1803-1871, 20 years between 1929-1949, and 40 years between 1968-2009: https://www.surlytrader.com/wp-conte...Why-Bother.pdf

                    Stocks did provide a 2.5% risk premium over the entire 1802-2009 period, but when horizons are measured in a couple of decades rather than a couple of centuries, the outcome is less certain.
                    Erstwhile Dance Theatre of Dayton performer cum bellhop. Carried (many) bags for a lovely and gracious 59 yo Cyd Charisse. (RIP) Hosted epic company parties after Friday night rehearsals.

                    Comment


                    • #11
                      Bonds have never made sense to me. They're an easy way for municipalities, large corporations etc. to get cheap money from you. They're lousy loans, not really investments although they are called such to get your money. Might as well go with REIT's for performance. Cream of the crop though is hard real estate for the best balance of dividends (lease revenue), appreciation, and tax depreciation. Or put that cheap money toward your own business. Where do you think your bond purchases go? Infrastructure investments and corporate expansion. You're missing our on the real returns earned by the recipient.

                      People here seem to struggle with the differences between what is an investment, a loan, a drag. A DOW well below 29K is currently the drag on bonds, CD's, HYSA, cash under the bed since February. People feel good buying a little extra peanuts relative to their portfolio after the market corrects. In reality you're stuck with the drag until recovery plus inflation adjustment - at times that takes 5+ years. In the case of Japan 30+ years and they're still not there. Stubborn misconceptions hurt long term returns.

                      As someone whose assets are multiple fold FI with multiple fold the income I need for FI, I can probably afford to lose 80% and still be FI. What good are bonds going to do? I just protect the investments and continue to invest in markets, RE, business expansion. I'll offer you a 1.5% guaranteed return (beats HYSA) to invest in my endeavors. Any takers? That's bonds for you.

                      28.97% YTD. My best mutual fund performer right now. What recession? Enjoy those bond returns.

                      Comment


                      • #12
                        Actually, yes, we do define it the same way for all of our clients. If you don't call an interest-bearing savings account an investment or a family loan an investment, why would you call a bond one? Just trying to use a little logic here and not lean on what others "think". Sure, it becomes an investment when it is spliced and diced into a fund that you own as an investment, same as a MMF is a kind of investment. We simply use bonds for a pure purpose - planned liquidity needs. This can certainly be calculated and a buffer added on top, as in my example. You are welcome to call it an investment; I choose not to.

                        I'm happy to agree to disagree on this one.
                        Our passion is protecting clients and others from predatory and ignorant advisors. Fox & Co CPAs, Fox & Co Wealth Mgmt. 270-247-6087

                        Comment


                        • #13
                          Originally posted by jfoxcpacfp View Post
                          Bonds and cash are for liquidity. As you know, I believe they are inappropriately used as investment "buffers". The only way to know how much to hold, however, is in the context of a financial plan.

                          One of our clients is approaching retirement and wants to hold 50% of funds in cash and bonds. This couple can afford to do so. The important point, though, is to understand the purpose of liquidity v investing. They can invest 50% in an appropriately-diversified equity fund portfolio and keep 50% liquid and live happily ever after. But bonds are not investments, although they are repackaged in funds and sold as such. They are debt to be repaid at a time certain. If they don't return more interest than a HYSA, then a HYSA is better. And I think they'll gradually change the proportions but, for now, we know they'll be just fine with that and be able to sleep at night.
                          Johanna, I just went back and reread your replies here to make sure I understood your perspective. I believe your answer to my question translates into action as follows: the equities are for long term gain. Do not think of bonds as a risk reduction allocation for the stocks; rather as liquidity (hold a store of value to spend). Other forms of liquidity are equally valid (e.g., HYSA or MMF). You are not commenting on other sorts of investments such as real estate. Fair? If so, then I think I may be close to your position in that my use of the term ‘buffer” was intended to identify the funds I wanted to protect during market drops. Your perspective is helpful because in that sense I probably have too much committed to bonds.

                          Comment


                          • #14
                            Originally posted by EntrepreneurMD View Post
                            Bonds have never made sense to me. They're an easy way for municipalities, large corporations etc. to get cheap money from you. They're lousy loans, not really investments although they are called such to get your money. Might as well go with REIT's for performance. Cream of the crop though is hard real estate for the best balance of dividends (lease revenue), appreciation, and tax depreciation. Or put that cheap money toward your own business. Where do you think your bond purchases go? Infrastructure investments and corporate expansion. You're missing our on the real returns earned by the recipient.

                            People here seem to struggle with the differences between what is an investment, a loan, a drag. A DOW well below 29K is currently the drag on bonds, CD's, HYSA, cash under the bed since February. People feel good buying a little extra peanuts relative to their portfolio after the market corrects. In reality you're stuck with the drag until recovery plus inflation adjustment - at times that takes 5+ years. In the case of Japan 30+ years and they're still not there. Stubborn misconceptions hurt long term returns.

                            As someone whose assets are multiple fold FI with multiple fold the income I need for FI, I can probably afford to lose 80% and still be FI. What good are bonds going to do? I just protect the investments and continue to invest in markets, RE, business expansion. I'll offer you a 1.5% guaranteed return (beats HYSA) to invest in my endeavors. Any takers? That's bonds for you.

                            28.97% YTD. My best mutual fund performer right now. What recession? Enjoy those bond returns.
                            Thanks for the perspective on “hard” real estate. I am inclined to agree there since interest rates do tend to encourage putting the capital to work in income producing properties.

                            Comment


                            • #15
                              It’s interesting that sovereign risk is not thought about as a risk in developed markets anymore with government bonds.

                              Bonds (or mortgages) definitely are an investment. In stocks and property markets - they are the substructure underneath equity. Looked at another way, the recent fed interventions saved equity in some enterprises. If this had not occurred equity would have been wiped out and the bond holders would have become equity owners. This is the basis for distressed company investing, where vulture funds buy debt in distressed companies with the expectation that they will come out with equity post bankruptcy.

                              The interest rate suppression globally has a terrible effect for retirees. At current US 10 year rates, you would need 15M in bonds to generate 150k/year. Very few have enough to retire on government bond income.

                              Possible options, which all have their specific risk
                              1. look international
                              2. Wait for a crisis and buy high yield corporate indexes
                              3. Overweight equities and hope equities do ok

                              It will be interesting what the endgame will be for government bond yields. Japan is possibly closer to that point, where currently the BOJ owns 51% of the JGB’s issued. In Japan the 10 year government bond yield is 0.008% pa. Hopefully the developed market sovereign failure endpoint if it occurs, occurs beyond our lifetime horizon.

                              With US government bonds, I have not held them for 2 or 3 years. The risk vs potential return is just not worth it to me.

                              On a 10 year US currently, return is 1%. Inflation is expected to be over 1%. What is the default risk ? Surely it is not zero on a long term horizon. Maybe I am thinking about it wrong, but bonds seem to me more overvalued than stocks.

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