Investing for retirement has never been easy, but today’s zero-interest rate world is forcing advisors and their clients to attempt a high-wire act. What makes it particularly challenging is that most clients in or approaching retirement were conditioned decades ago to believe they should be able to save enough to preserve their capital and live off the income it produces.

To do that today, an individual needs to be wealthy or frugal or both. As bonds and stocks have soared in value thanks to easy monetary policies and an aging population, the cost of retirement income has grown increasingly expensive.

Americans are not alone—it’s a global problem. But more than a few advisors believe that part of the solution lies in finding value and income outside the U.S. In fact, the valuation differential between the U.S. and other developed stock markets is near an all-time high, prompting some advisors like Tom Connelly, president and chief investment officer of Versant Capital Management in Phoenix, to tilt portfolios toward value stocks, particularly those outside the U.S.

BlackRock’s iShares Core MSCI Europe ETF yields about 2.4%, while the S&P 500 yields only 1.3%. Neither figure is especially juicy. Over the 12 months ended September 14, both indexes have mirrored each other, returning just over 30%.

After 10 years of growth outperforming value, advisors are seeing some client prospects enter their offices with portfolios out of whack just when market leadership might be at an inflection point. Both styles have performed well this year. In the U.S., the iShares Russell 1000 Growth ETF was up 17.9% so far in 2021, while the ETF based on its value index counterpart was up 20.2% as of September 14.

If one drifts further out on the growth spectrum where the air is thin, however, danger signs are apparent. For instance, Cathie Wood’s $25 billion flagship ARK Innovation ETF was down 3.5% for the same period.

Risks Reaching For Income
Preserving capital and living off the income is still possible. But Connelly says clients are likely to be taking some kind of risk, be it “illiquidity, duration, credit or optionality”—the last being a reference to those bonds that offer more income but come with an embedded call option.

Connelly points out that many instruments favored by yield-hungry investors, ranging from mortgage REITs to preferred stocks to high-yield and emerging market bonds, suffered just the same fate equities did in both the financial crisis and the brief but violent Covid bear market. With many of these vehicles, he sees the risk of permanent capital impairment.

Congress and the Federal Reserve bailed out the financial markets in both crises. But it’s a fair question to ask how willing senators as diverse as Kentucky’s Rand Paul and Massachusetts’s Elizabeth Warren will be to bail out markets next time. Connelly also notes there is no guarantee the next bailout will be as successful as the last two.

The REIT market still offers exposure to certain properties like data centers and multi-family housing yielding 5% or 6%, according to Michelle Connell, CEO of Portia Capital Management in Dallas. But she says advisors and other investors need to examine the underlying properties, since the higher their yield is, the greater the likelihood they will require expensive renovations.

Another risk receiving lots of recent headlines is inflation, of course. Don Wilson, chief investment officer at Brightworth in Atlanta, has spent considerable time this year reading experts on both sides of the debate, and he remains agnostic in his views and portfolio positioning.

Brightworth does deploy some client assets to inflation-friendly investments like TIPS, commodities, real estate and gold. But Wilson notes that some of these asset classes can be volatile, particularly gold and commodities.

“You don’t need a huge allocation,” he says. But if inflation does make a comeback, placing 5% or 10% of a portfolio in these investments will provide some protection.

Both Connelly and Wilson also worry about duration risk. “Unless rates go significantly negative, there is little room for bond prices to rise,” Wilson says.

Even an intermediate bond fund with quality holdings could suffer an 8% to 10% decline if interest rates rise, he explains. The fallout could be significant across an array of asset classes, including most bonds as well as both dividend-paying value stocks and long-duration technology shares.

Growth Of Capital
In today’s world of lofty asset prices, there’s another source of retirement income besides dividends and interest—growth of capital, which means selling appreciated assets. For many clients, it can entail a major shift in their mindset, notes Cheryl Holland, president of Abacus Planning Group in Greenville, S.C.

“It can take them three to five years to get comfortable with the concept,” she says. But “markets are so high and inflation is rising. We’ve never had that mix of data in my career.”

Persuading clients to sell appreciated assets after a decade of 14% annual returns requires educating them about a total return approach. “If [they] are not tapping into investment gains,” clients could be exposing themselves to additional risks, says Chad Carlson, president and chief investment officer of BDF in Itasca, Ill. Those potential risks could leave them in a position where they are either going to underspend or be under-diversified.

Before she was a financial advisor, Connell of Portia Capital recalls losing arguments with high-tech executives about their failure to diversify in the late 1990s. It doesn’t give her any pleasure that she was right.

David Yeske, managing director of Yeske Buie in San Francisco, seconds the notion that diversification helps, and says he’s relied on broad global diversification for decades. “For 10 years prior to the Great Financial Crisis, our clients didn’t have a lost decade,” he says, referring to the 2000-2010 period when U.S. stocks flatlined.

Asset allocation decisions also are critical. Yeske is an outlier in this area. His clients’ portfolios typically have 80% in equities, slightly tilted outside the U.S., and 20% in bonds until they retire, when another 10% is shifted into fixed-income assets.

Yeske views the fixed-income allocation more as a stable reserve than a source of income. “A 30% allocation [to bonds] will sustain a seven-year bear market” in stocks, he explains.

Financial advisors aren’t the only ones seeing soon-to-be retirees walk into their offices asking how they can buy the pensions they never had. A former Fidelity executive reports their retail branches see it almost daily.

The clients are seeking pensions, but more than a few end up buying annuities with little or no commissions. The retired executive cites the case of a relative who recently took about 50% out of the gains he had made in his managed account since the March 2020 lows in the stock market and used half the appreciation to buy an annuity. These products may offer guarantees, but they’re like all other sources of retirement income today: In other words, nothing is cheap.