By Anne Tergesen
Nov. 13, 2023
The investing strategy millions of Americans rely on to secure a good life in retirement hasn’t worked lately. They should probably stick with it anyway.
Illustration by Alex Nabaum
Most people keep their 401(k) on autopilot by investing in a diversified portfolio of stocks and bonds. Faith in this approach has been shaken by three years of losses in the bond market.
It is being further shaken now. With yields on government bonds around 5%, some are thinking of taking money out of stocks to put it into bonds.
As tempting as it may be to meddle with your investments, history suggests most investors have a lousy record of timing the market. Financial advisers say the vast majority of Americans should stick to time-tested advice and simply do nothing.
“Just because your strategy has a bad year or two doesn’t mean you should make changes,” said William Bernstein, a financial adviser and author of “The Four Pillars of Investing.” “Even the best strategies are going to have a bad year now and again, so the best thing you can do is pick an investment mix that’s reasonable and stick with it.”
Investors’ desire to take their nest eggs off autopilot is understandable. In 2022, a balanced portfolio evenly split between stocks and bonds lost 15.5%. This year, a 50/50 portfolio is up about 7.9%, even as the S&P 500 index has risen 16.6%.
Meddling with your 401(k) is a major step that can leave investors worse off than if they stick with a balanced portfolio. Bonds have performed poorly in recent years, but both bonds and stocks still play a vital role in building retirement security.
Stick with target-date funds
Americans have funneled a large percentage of their 401(k) savings into target-date funds, which shift from stocks to bonds as retirement draws nearer. Designed to give investors a set-it-and-forget-it approach, they are the default options in many plans.
These funds have struggled recently. Portfolios for people planning to retire in 2040 fell 17.3% in 2022 before rising 3.7% through Oct. 31, even as the S&P 500 gained 10.7% including dividends over that time.
Funds that combine stocks and bonds tend to earn steadier returns than those that invest in a single asset class, such as stocks, although they can cost slightly more. That makes it easier for people to stick with stocks, which have greater growth potential than bonds, in bad markets, said Amy Arnott, a portfolio strategist at Morningstar and co-author of the report.
“Target-date fund investors leave their investments alone, which is the best thing to do if you’re trying to build long-term wealth,” Arnott said.
In 2022, only 2% of target-date fund investors traded their holdings, versus 11% of other 401(k) investors, according to Vanguard. Studies have found that investors who trade frequently are more likely to buy after rallies push prices up and sell when markets are depressed and their holdings are beaten down.
Target-date fund investors have kept all but 0.46% of the 6.44% average annual gain their funds have earned over the past decade. In contrast, investors in a broad array of funds, including those specializing in stocks and municipal bonds, forfeited 1.7% of their annual gains, Morningstar found.
Don’t give up on bonds
In recent decades, bond prices have often gone up when stocks fell. This is one reason why they are an important part of a diversified portfolio.
But when inflation heated up in 2022, stocks and bonds fell in unison. The S&P 500 lost 18.1%, with dividends reinvested, while the widely tracked Bloomberg U.S. Aggregate bond index declined 13%.
If inflation persists, some financial professionals predict an era in which simultaneous stock and bond declines are more common. As a result, they argue, building a nest egg by rebalancing a mix of stocks and bonds may not work as well as it has in the past.
Bonds are still worth holding, said Bernstein.
For one thing, it is impossible to predict what inflation or interest rates will do. And over the long time horizons many retirement investors have, bonds are still likely to provide some protection when stocks fall, he said.
Now is almost the worst time for investors to sell bond funds, said Roger Aliaga-Diaz, global head of portfolio construction at Vanguard. Investors who do so will lock in their losses just as bonds are producing higher income streams, he said. Over time, the fatter yields will result in higher total returns, making up for the losses of the past few years, he said.
The more investors earn on bonds, the less stocks have to return for them to meet their retirement goals, said Brendan Mullooly, an adviser in Wall Township, N.J.
“Bond yields’ rising has inflicted short-term pain on investors but it will make the retirement income math much easier moving forward,” he said.
Consider TIPS
At 4.6%, the yield on the benchmark 10-year Treasury is higher than it has been in more than 15 years.
But after accounting for the inflation the bond market expects over the coming decade, the real yield is just above 2%. If inflation exceeds expectations, it will erode the value of the bond income.
Until the risk of higher inflation subsides, retirees should consider two strategies, Bernstein said.
One is to invest in short-term Treasury bonds, with maturities of up to about three years. Since their prices are less sensitive to changes in interest rates, funds that invest in short-term U.S. government bonds have lost 1.68% annualized over the past three years, versus a 16.57% annualized decline for long-term U.S. government bond funds over the same period, according to Morningstar.
Another strategy is to buy TIPS, or Treasury inflation-protected securities, of varying maturities.
In the beginning of 2022, the real yield on the 10-year TIPS was negative. Today, investors can lock-in a 2.3% yield. If investors hold TIPS to maturity, they are guaranteed that annualized return, because the bond’s principal adjusts for inflation.
Allan Roth, an adviser in Colorado Springs, Colo., recently built a $1 million ladder of individual TIPS that mature at intervals over 30 years. The principal on the bonds that mature each year plus the income payments on longer-term holdings will provide inflation-adjusted cash equal to about $45,000 a year in today’s dollars, he said.
The ladder allows him to spend 4.5% of his $1 million investment each year, exceeding the 4% spending rate that’s considered safe for new retirees with a 30-year horizon. The TIPS ladder will be depleted after 30 years, while the stock-and-bond portfolio may not be.
Roth recommends capping TIPS exposure at 30% of the bond portion of a portfolio. Two independent sites that offer advice on making a ladder are tipsladder.com and EyeBonds.info.
Write to Anne Tergesen at anne.tergesen@wsj.com
Dow Jones & Company, Inc.
