Retirement Planning Has Completely Changed – Next 10 Years Will Be Tough

Summary

  1. Everything has changed in retirement planning in just the past few years.
  2. Formerly financial planners would recommend “laddered bonds” that would allow you to have a steady income stream with little risk.
  3. Bonds worldwide no longer pay the interest necessary to support the typical 4% retirement drawdown many people need to retire. Some bonds pay negative interest.
  4. The situation may not change in the next 10 years.
  5. There are alternatives, but you need to understand them.

Today, the 10 year US Treasury is paying about 1.8%, a very far cry from 5% – 15% they paid from 1968 to 2009. Even at 1.8% the US 10 year is viewed as very attractive to the rest of the world when many bonds are paying much less or negative yields.

For an entire generation, financial planners helping people develop their retirement plans counted on bonds to provide not only safety but also fixed income. The planner would suggest “laddering” bonds or even high yield CD’s. Many time they would just put you into bond mutual funds that did the laddering for you automatically. Laddering meant that you would start by buying say a 1 year bond, a 5 year and a 10 year bond or Treasury note. When the 1st bond expired you would just roll it over into a 2nd bond, etc. This way every few years you had a bond expire (called away) and you could hopefully buy the next one at higher rate. If you owned enough bonds with different maturity dates you could count on a steady stream of income that allowed you to draw down your 4% a year and still accommodate for inflation. This was the most recommended and preferred retirement investment strategy. This doesn’t work anymore. Here is what the 10 Year Treasury yielded from 1950 to 2016.

Ladder

Today however, with such a low bond yield worldwide there is new generation of retirees that are either retired today or will retire in the next 10 years that are searching for a new financial plan. Economist are now saying that we should prepare ourselves for 10 years of relatively low yields, say 1.5% – 3%.

The problem is that the 4% draw down model does not work with 1.5% – 3% yields and 1-2% inflation. You run out of retirement income way too early. Even if you follow a more aggressive investment model of 60% bonds 40% stocks and bonds stay in the 2-3% range you need huge returns on stocks to hit your 4% goal.

Here is the problem for the next 10 years. Notice the downward trend in 10 year yields and a new base being established in the 1.8 – 3% range.

Ladder-2

What can you do?

  1. Assume you need to maintain a 4% draw down rate in retirement, you probably need a consistent 6-7% yield/growth on your investments to accommodate for inflation.
  2. Always remember bond yields move directly opposite from bond prices.
  3. The key is to substitute “bond like” equities that offer higher yields for traditional bonds.
  4. Plan on maintaining a higher equity (stocks) proportion of your portfolio well into retirement. Today you could easily be in you 80’s and still have a 50/50% bond/stock portfolio. In past years at 80 you would own 100% bonds and CD’s.
  5. Continue to fine tune your financial retirement plan, you will live longer than you think, you need to be debt free in retirement and you need to manage expenses.
  6. If you develop a good plan and pay attention to it, you can retire comfortably and sleep at night knowing you can meet your goals.
  7. Your plan might be to spend all your money before you die, or leave a legacy (money) to your loved ones for them to enjoy.

In a future article I’ll provide some suggestions on how to build a 6-7% yield/growth portfolio.

 

 

 

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