The sands of retirement income investing have shifted in the last year to the point where financial advisors are leaning into fixed-income investments with an intensity not seen in more than a decade.
Even die-hard equities lovers, like Heidi Huiskamp Collins, founder of Huiskamp Collins Investments in Bettendorf, Iowa, have been surprised by their own enthusiasm for the asset class. Fixed income was previously appreciated mainly for its ability to dampen the volatility of equities, not for its ability to make money.
“This whole year I have been shying away from equities. I’ve been putting new money from clients into Treasurys and also into some corporate bonds. Mostly Treasurys. And then also six-month CDs,” she says.
Huiskamp Collins says she usually likes to remain moderately aggressive with her clients’ assets when they first enter retirement, anticipating that they might live to 95. Before 2023, her portfolios for recent retirees in their 60s were typically 60% to 70% stocks.
Not anymore. It’s not that she has soured on stocks but rather she believes there is a unique opportunity in the bond market. “I’ve got access to really nice CDs for six months paying 5.4%. You just can’t beat that. We haven’t seen anything like that in years,” she says. “I’m getting a lot of people coming off the sidelines to do that kind of income investing, and they’ve been really happy.”
Her conversion into a fixed-income cheerleader is hardly an anomaly in the advisory industry. Though their techniques vary, advisors around the country have made the same adjustments after a year of economic uncertainty.
Last year, investors in general were battening down their financial hatches, assuming that 9.1% inflation in June 2022 would force the Fed to engineer a recession to let the wind out of those inflationary sails. The fears of higher unemployment and depressed corporate earnings cast a pall over investor optimism—and many bet the landing would be hard and painful.
Beginning in March 2022, the Fed began raising its funds rate, eventually reaching between 5.25% and 5.50% through 11 incremental increases over 16 months. According to advisors, what this means for retirees (and those about to join their ranks) is that there is a limited window to lock in some of the best fixed-income returns in recent memory. Because once the Fed declares mission accomplished, perhaps sometime next year, those rates may be coming down (with any luck).
In fact, some think the rates have already topped out. That includes Saira Malik, chief investment officer at Nuveen in New York.
“Given our perspective on moderating inflation and Fed policy, we believe yields—including the bellwether 10-year U.S. Treasury yield—have likely peaked for this interest rate hiking cycle,” she wrote in a mid-September email. “The 10-year yield has typically peaked within the last few months before a final Fed rate increase, which in this case we anticipate will occur no later than the first day of November.”
The Fed has telegraphed one more hike of 25 basis points, potentially in September (which would be right after this issue of Financial Advisor has gone to press). The central bank is then expected to hold interest rates at the current level to see how effective its strategy has been.
Additional rate hikes aren’t off the table for next year (depending on what inflation does), but advisors now say they’ve got a better grasp of market dynamics and how it will affect retirees’ peace of mind. “We know that there’s a level of inflation that’s higher than it was before. That’s here to stay for a bit,” says Jamie Hopkins, formerly managing partner of wealth solutions at Carson Wealth in Omaha, Neb. “Interest rates have been raised to combat that with good and bad effects on assets. But a year ago, when inflation was spiking, that was a very scary prospect because people didn’t know where it would cap out at. There were fears of, ‘What if this thing gets to 15%, 16% per month for a year or two?’ And that’s a very scary world. Those fears have calmed down.”
Capitalizing On Market Conditions In Multiple Ways
For the most part, the hikes in interest rates have been great for retirees, advisors agree. After all, cash reserves that earned next to nothing before can now get 5.29% in a Vanguard money market account. Yet many clients haven’t taken advantage of those bigger rates, Hopkins says.
“You can still look at people’s cash sitting in a traditional bank in a money market paying less than 1%,” he says. “Well, there’s places out there paying 5% for that. That is a tremendous amount of money you could be giving up if you’re early in retirement.”
Besides money market funds, Hopkins says there are cash equivalents to be found at places like BlackRock, State Street and WisdomTree. “There’s not a lot of risk associated with those because they’re just federal Treasurys in an ETF format. Those are equivalents to a cash account or a money market account that we didn’t have a decade ago,” he says. “But if you’re worried about drawing down 4% a year on your portfolio and making it last, well, you could go lock in 5% today in fixed income and stop worrying.”
This is one reason for Huiskamp Collins’s new-found love affair with fixed income.
“I haven’t been doing bond ladders for years, but at the beginning of the year I started using that strategy for clients to enjoy income and retirement,” she says. “We’re doing bond ladders with Treasurys and also with CDs. Rather than tapping equities, I’m letting equities grow, as they have this year.”
Equally enamored with bond ladders is Allan Roth, the founder of Wealth Logic in Colorado Springs, Colo., who focuses on both return and money protection. He’s particularly concerned about wealth erosion from inflation.
“It scares the heck out of me,” he says, adding that, like other advisors, he’s been building ladders, though in his case they’ve been Treasury Inflation-Protected Securities ladders. “The TIPS rates are incredible now, and it’s a very different solution than I would have had in the past. But you can build a TIPS ladder today to give a 4.47% safe withdrawal rate for 30 years.”
The advantage of that, Roth says, is that no matter what happens to the market or to clients’ other assets, there’s a stable, inflation-adjusted income helping fund the retirement they worked hard for.
“A client’s retirement portfolio represents their choices in life. They were programmed to live below their means, to store money, to put money away. Then suddenly they’re in retirement. The thought of spending it down is incredibly scary,” he says. “But there’s that TIPS ladder. It actually gives them permission to spend.”
Other advisors say the new fixed-income strength doesn’t require a new strategy so much as a refining of their otherwise successful portfolio construction. For example, Rick Adkins, president and CEO at the Arkansas Financial Group in Little Rock, works primarily with retiring doctors. He’s built his firm on a process anchored in diversification, set allocations and Zen master-level discipline.
“We don’t change our allocations,” he says. “Within short fixed-income I may use a different product. It may be a traditional short corporate ETF or a mutual fund. It could be a CD. But we’re really locked to the allocation.”
And that’s where responsiveness to market conditions will come in. If his allocation model gets out of whack, he rebalances, taking money from investments that have done exceptionally well and buying into those doing poorly.
“That’s why the process is so important, right? Because human nature is we want to buy into a winner, and that’s the worst thing you can do.” He adds that anytime an asset class is 25% off plan, he rebalances no matter how hard it is to exit winners.
Jason Siperstein, a retirement specialist at Eliot Rose Wealth Management in East Greenwich, R.I., also stands by his firm’s investment philosophy, informed by its business model. Unlike typical advisory firms, the firm only takes clients a year or so from retirement or already in it; most of them have between $1 million and $5 million in retirement savings.
“We find people know how to accumulate money,” he says. “We see our job as helping them enter this new phase where they’re spending it.”
The firm’s typical client portfolio is halved, split between growth assets and what the firm calls “paycheck replacement.”
“This is the point in life where a client’s portfolio is tethered to their living expenses. So it’s very important to be able to generate cash when a client needs it, as opposed to taking money out when something’s down,” he says.
The growth side is invested in a diversified asset mix that includes equities, alternative investments and some bonds. The paycheck replacement side is almost never invested in an annuity, which Siperstein says can be burdened with significant fees. Instead the firm builds cost-efficient, liquid, flexible portfolios with high-quality, short-term, investment-grade bonds.
For those clients who retire before claiming Social Security or before required minimum distributions kick in, Siperstein says he will address paycheck replacement with a bond ladder made up of investments in State Street bond-basket ETFs.
“What you get is a basket of bonds in a single-solution ETF. If a client doesn’t have $1 million for that bond portion of the portfolio, it’s really hard to develop a bond portfolio that actually matures at a certain point in time,” he says.
“We want that certainty,” he continues. “Right now we’re seeing 5.5% to 6.5% at maturity dates. So we’ll just go out to 2024, 2025, 2026, 2027, whatever it may be. That sort of gets us through most bad markets.”
Still Some Flies In The Ointment
While there’s been plenty to cheer about on the investment side, there is bad news, especially for those clients who thought they’d relocate in retirement and buy a new residence. Mortgage rates, now at 8%, have put a wet blanket on that idea. Many of these clients are locked into very low interest rate mortgages on their current home—sometimes 2% to 3%—so even if they went with the same size loan, any change might double their cash outflow for housing every month, or worse.
“And that might not be a one- or two-year impact,” Hopkins says. “We could see that impact on retirees for five to 10 years from now. It used to be you didn’t have to worry about that too much. You bought the next place at roughly the same interest rate, and cash flow stayed pretty consistent. But rates have tripled for some people. That’s a really big jump in your payments.”
So instead of moving, sensible retirees are choosing to redo their kitchens or build additions to bring their current home closer to their ideal.
And after three years of dealing with the unprecedented, plenty of Americans want to retire early (having had enough of the grind). Unfortunately, their portfolios don’t always accommodate that idea, Huiskamp Collins says.
“I’m telling more and more people who come in at age 62 and want to retire now, ‘You need to work longer, especially getting to age 65. You have to have healthcare.’ I wasn’t having that conversation as much in the first 19 years of my practice, and this is year 20,” she says.
These clients may have worked 30 or 40 years, but they’re struggling to get over the finish line, she says. Some of them are “quiet quitting.”
“I’m seeing it with 50- and 60-year-olds. They’re tired. They’re done. I think Covid really impacted a lot of folks in that age group, and they feel like they deserve it. I have to be the one to say, ‘You may feel like you deserve it, but this doesn’t make any financial sense and you’re going to be in a world of hurt if you proceed. You’re going to be eating cat food if you retire at 62.’”
One client, she says, did proceed—a 62-year-old woman who was part of a twosome with a couple hundred thousand dollars in their 401(k), a mortgage, credit card debt and two car payments. “She came in and just said, ‘Well, I did it, I retired,’” Huiskamp Collins says. “No money for healthcare, and it’s going to be very, very expensive for them. They expect me to wave my magic wand and make it all better. It just took my breath away.
“So I told them, ‘Well, Costco’s hiring, and Costco has medical benefits for part-time workers. So this is what you need to do.’ At that point, what do you say?”
Perhaps A Soft Landing After All
Some reckless client behavior aside, most clients are in a much better position now with their retirement income than they were a year ago, or at least can believe so.
While the clouds have not completely parted on this economic storm, many industry sources agree that the worst-case scenarios they were prepared for last year have yet to materialize. Inflation has declined to a much more manageable 3.18%. Yes, employment has slightly ticked up to 3.8%. But the S&P 500 as of September 11 was up 17.35%.
“At the beginning of the year, I thought there was a 100% chance we were going to have a recession. I was ready to take it to the bank. Now I’m dialing it back,” Huiskamp Collins says. “I really didn’t think that was in the cards. But the American consumer continues to surprise me with their spending that has been propping up the economy. We may just have a soft landing, which would be the best of all worlds.”