Aging Into Bonds
REMEMBER WHEN YOU got that first AARP card in the mail? I must have been 50, not at all ready to begin thinking about senior discounts, and slightly offended. That was 12 years ago.
Well, I’m feeling that way again. You see, the grim reaper—oops, I mean retirement—is getting close. That means it’s time to reduce my exposure to stocks, while boosting my holdings of income-oriented investments. It’s a strange feeling for someone who has spent his life investing almost exclusively for capital appreciation.
On the one hand, such an adjustment in my asset mix should be strictly by the book, as though I’m running my own target-date fund. Unemotional, mechanical, and free of any ideas about tactical asset allocation. Just part of a long-held plan.
On the other hand, I’m concerned about a richly valued stock market propped up—at least until recently—by the “magnificent seven” glamour stocks. In response, I’m considering a tactical move: a bigger cut in my stock allocation than I’d initially planned and, with part of the proceeds, a bet on both high-quality and high-yield corporate bonds.
Over the next 10 years, some experts project that bonds could match or beat the stock market indexes. Asset management firms like Vanguard Group, PIMCO and Oaktree Capital Management are pounding the table for bonds. In fact, Oaktree Co-Chair Howard Marks is calling for a fundamental reassessment of the typical stock-bond mix in favor of more bonds, especially corporates.
My old plan was to reduce my stock allocation from its current 72% in increments of one or two percentage points per year as I age. I planned to shift money to short-term Treasurys and other safe options, which I’ve generally preferred for the bond and cash part of my portfolio. That’s partly because part of the 28% non-stock part of my portfolio doubles as my emergency fund.
But even though I already have a hefty allocation to safe bonds and cash, I feel exposed to the risk that the tech giants that dominate the U.S. market are overvalued. Experts talk about the high Shiller cyclically adjusted price-earnings ratio of 32, the low stock market risk premium and—by historical standards—the low S&P 500 earnings yield of 3.8%. Vanguard is projecting paltry returns of 4.2% to 6.2% annually for large-cap U.S. stocks over the next decade.
That makes me think of cutting perhaps three percentage points from my stock allocation at the end of this year—greater than what I’d planned. Instead of shifting that money into my usual safe-haven options, I’m considering an allocation to riskier vehicles such as corporate bonds, including high-yield “junk” bonds, in a bid for strong returns with less risk.
I already own some high-quality and high-yield corporate bonds, almost all through balanced funds that I inherited. I also have a very small and slowly growing position in a junk-bond fund in my 401(k).
Vanguard expects high-yield bonds to notch returns of 6.3% to 7.3% annually over the next 10 years, outperforming U.S. stocks. That’s not the same thing as recommending junk bonds right now. Vanguard’s fixed-income experts are concerned about a recession in 2024, and thus for the moment favor high-quality bonds.
Over most of my investment lifetime, the stock market has been driven in part by declining interest rates. But that favorable environment appears to be over, and today’s higher interest rates and rich stock valuations may now create a headwind for U.S. shares. Price-earnings ratios may not rise over time, as they have throughout the past four decades. Dividends from stocks and interest paid on bonds may become greater components of total return.
If you think stocks might return 8% or less a year over the next decade, rather than the 10% average annual return of the past century, then an investment-grade corporate bond fund with a 6% yield doesn’t look bad. In fact, in its capital markets assumptions, Vanguard projects intermediate-term corporate bond returns of 5.2% to 6.2% a year.
That could match or exceed those of U.S. stocks over the next decade—and do so with much lower volatility. Still, market action could influence my decision, especially if the yield advantage of corporate bonds over Treasurys narrows too much.
William Ehart is a journalist in the Washington, D.C., area. In his spare time, he enjoys writing for beginning and intermediate investors on why they should invest and how simple it can be, despite all the financial noise. Follow Bill on X (Twitter) @BillEhart and check out his earlier articles.
The post Aging Into Bonds appeared first on HumbleDollar.
