Why Investors Should Rethink Traditional Income Strategies
Humans are creatures of habit. We all have daily routines, whether it’s walking the same lunchtime route, watching a familiar TV show, or cooking the same meal over and over again. Once we develop a pattern, it can take a drastic change to convince us to rethink our approach.
One such shake-up to ingrained investment habits is the changing landscape of income investing.
In today’s infographic from New York Life Investments, we explain why traditional long-term bonds may not be as effective as they were in the past, and which additional income strategies investors can consider.
The Status Quo
For years, investors have relied on traditional longer-term bonds as the centerpiece in an income portfolio. These debt instruments usually pay out interest to investors on a predetermined schedule, providing a steady income stream investment. Historically, they have also been subject to less volatility than equities.
The typical bond portfolio is diversified, much like the Bloomberg Barclay’s U.S. Aggregate Index. Here’s how the sectors are broken down in the index:
Unfortunately, this income strategy has been less effective in recent years. Over the last decade, core bond duration has increased by 1.5 years while yields have decreased by almost 2%. Essentially, interest rate volatility has increased—but investors are less compensated for the risk.
In light of low rates and higher expected market volatility, it’s critical that investors explore other income solutions. Luckily, there are many lesser-known asset classes for investors to consider.
Additional Income Strategies: An Investor’s Choice
When investors decide how to re-allocate, they can keep these objectives in mind:
- Preservation of principal (risk level)
- Pursuit of capital (growth potential)
- Perseverance in markets (long-term objectives)
Which additional income strategies can they explore?
Taxable Municipal Bonds
Issued by state and local governments, the yield of taxable munis has historically been higher than that of other sectors. Taxable munis also have a strong credit rating—over 76% of U.S. municipal bonds outstanding are A+ rated or better.
Insured Municipal Bonds
Investors can get additional downside protection with insured municipal bonds, which are guaranteed to pay interest and principal back by private insurers. They have historically performed similar to munis while capturing less of the “downside”, often providing an attractive risk-adjusted return for income investors.
Short-duration, High-yield Bonds
Bonds with a shorter duration and higher yield can be a lower volatility approach to achieving the same income investing goals.
Yield and Risk in Bonds (July 1, 2014 – June 30, 2019):
|Bond Type||Yield||Standard Deviation (annualized)||Yield per Unit of Risk|
|U.S. Aggregate Bonds||2.49||2.94||0.85|
|High Yield Bonds||6.05||5.60||1.08|
|Low-duration, High-yield bonds||5.00||3.90||1.28|
Short duration funds have lower interest rate risk, and can offer attractive yield per unit of risk.
Equities can also play a role in an income focused portfolio. Investors should look for established companies that are achieving:
- Growth in free cash flow
- Stable or growing dividends
- Share buybacks or debt reduction
Over the last 40+ years, the annual compound return of stocks with growing dividends have outperformed dividend cutters on the S&P 500 by more than 4%.
Preparing for Your Future
Maximizing the benefit from new income opportunities can take time. For this reason, it’s important to consider potential portfolio changes now, so that these strategies can play out in the lead up to retirement years.
It may be tempting to stick with the status quo—both in daily routines and investment strategies—but those who proactively adjust their approach will be able to maximize their potential.
How Equities Can Reduce Longevity Risk
With life expectancies increasing, will you outlive your savings? Learn how allocating more of your portfolio to equities may reduce longevity risk.
Will You Outlive Your Savings?
The desire to live longer — and outrun death — is ingrained in the human spirit. The first emperor of China, Qin Shi Huang, may have even drank mercury in his quest for immortality.
Over time, advice for living longer has become more practical: eat well, get regular exercise, seek medical advice. However, as life expectancies increase, many individuals will struggle to save enough for their lengthy retirement years.
Today’s infographic comes from New York Life Investments, and it uncovers how holding a stronger equity weighting in your portfolio may help you save enough funds for your lifespan.
Longer Life Expectancies
Around the world, more people are living longer.
|Year||Life Expectancy at Birth, World|
Despite this, many people underestimate how long they’ll live. Why?
- They compare to older relatives.
Approximately 25% of variation in lifespan is a product of ancestry, but it’s not the only factor that matters. Gender, lifestyle, exercise, diet, and even socioeconomic status also have a large impact. Even more importantly, breakthroughs in healthcare and technology have contributed to longer life expectancies over the last century.
- They refer to life expectancy at birth.
This is the most commonly quoted statistic. However, life expectancies rise as individuals age. This is because they have survived many potential causes of untimely death — including higher mortality risks often associated with childhood.
Amid the longer lifespans and inaccurate predictions, a problem is brewing.
Currently, 35% of U.S. households do not participate in any retirement savings plan. Among those who do, the median household only has $1,100 in its retirement account.
Enter longevity risk: many investors are facing the possibility that they will outlive their retirement savings.
So, what’s the solution? One strategy lies in the composition of an investor’s portfolio.
The Case for a Stronger Equity Weighting
One of the most important decisions an investor will make is their asset allocation.
As a guide, many individuals have referred to the “100-age” rule. For example, a 40-year-old would hold 60% in stocks while an 80-year-old would hold 20% in stocks.
As life expectancies rise and time horizons lengthen, a more aggressive portfolio has become increasingly important. Today, professionals suggest a rule closer to 110-age or 120-age.
There are many reasons why investors should consider holding a strong equity weighting.
- Equities Have Strong Long-Term Performance
Equities deliver much higher returns than other asset classes over time. Not only do they outpace inflation by a wide margin, many also pay dividends that boost performance when reinvested.
- Small Yearly Withdrawals Limit Risk
Upon retirement, an investor usually withdraws only a small percentage of their portfolio each year. This limits the downside risk of equities, even in bear markets.
- Earning Potential Can Balance Portfolio Risk
Some healthy seniors are choosing to work in retirement to stay active. This means they have more earning potential, and are better equipped to recoup any losses their portfolio may experience.
- Time Horizons Extend Beyond Lifespan
Many individuals, particularly affluent investors, want to pass on their wealth to their loved ones upon their death. Given the longer time horizon, the portfolio is better equipped to ride out risk and maximize returns through equities.
Higher Risk, Higher Potential Reward
Holding equities can be an exercise in psychological discipline. An investor must be able to ride out the ups and downs in the stock market.
If they can, there’s a good chance they will be rewarded. By allocating more of their portfolio to equities, investors greatly increase the odds of retiring whenever they want — with funds that will last their entire lifetime.
The Periodic Table of Investments
The investment universe is vast – but it’s also made up of many smaller components. See it all depicted in this nifty periodic table of investments.
Periodic Table of Investments
The investment universe is vast, but it’s also made up of many smaller moving pieces.
For serious investors, the foundation of the discipline is to understand the properties of these individual components, and to have them work in harmony to achieve a specific portfolio goal.
To do this successfully, one must understand the breadth of asset classes, tactics, and categories of investments that exist – and to know how they relate to one another.
The Chemicals Between Us
Today’s infographic comes from Phil Huber, the Chief Investment Officer for Huber Financial Advisors, who has cleverly depicted this relationship graphically in his blog.
Similar to how the physical universe is made up of chemical elements, he sees the possibilities around portfolio management as drawing from a broad pool of investing “elements”. Combine these different elements together, and you get compounds, structures, and eventually entire funds.
The periodic table of investments created by his team denotes each type of investment, the primary and secondary strategy related to it, and a color classification:
Here are the seven objectives that the top letters on each box refer to:
And finally, here are the colors that each block on the periodic table correspond to:
As you can see, considerable thought has been put into the categories and classifications. However, as Phil notes, this is simply the opinion of one person and it is not intended to be a universally accurate depiction of all portfolio management wisdom that exists:
I fully expect that there are a handful of omissions, or perhaps a few areas where one might flat-out disagree with how I’ve laid things out. This was not meant to be 100% exhaustive, nor was it meant to be indicative of what one of our portfolios looks like.
Phil Huber, Chief Investment Officer
For more of the lessons that can be derived from this clever periodic table of investments, we suggest checking out the original post on Huber’s blog.
Is there anything that he missed, or that you think could be classified better?
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