What should investors nearing retirement be thinking about? Avoid overreaction. According to the U.S. Census Bureau the average length of retirement is 18 years. That’s a long time horizon from an investment perspective and gives investors nearing retirement plenty of time to recover. Significant negative returns in 2022 may tempt investors to implement major changes, but there are reasons to stay the course across different asset classes.
Interest rates have climbed substantially since the calendar flipped to 2022 with the U.S. 10-Year Treasury Yield moving from 1.5% to 4.2% before retreating to 3.7%. Rates are at levels not seen for nearly 15 years and interest-bearing securities are finally rewarding conservative investors looking for income. Those spooked by the volatility in 2022 may consider a shift toward fixed income knowing that they are being compensated with competitive rates.
It may also be a good time to review your marginal tax rate and asset allocation. Your wealth advisor and portfolio manager can compare tax-equivalent yields in municipal bonds with treasury yields and determine the most efficient allocation of fixed income among taxable and tax-exempt accounts.
Hot inflation forced the Federal Reserve to raise interest rates, which were not kind to equity market participants. The stock market suffers when interest rates go up. Discounted cash flow models project lower present values for stocks, and debt is simply more expensive for corporations looking to borrow. However, some optimism may be warranted as much of the market damage has likely been done.
What if stubbornly high consumer prices persist over the next few years? Equities outperform cash and fixed income during extended periods of inflation, especially high dividend and value stocks. In fact, the only inflationary environment over the last 30-plus years in which fixed income has outperformed equity is at levels under 1%, and we don’t expect to see inflation drop that low anytime soon. A proper allocation to equities will ensure your portfolio keeps pace with inflation while offering upside not available in safe-haven assets.
High cash balances in investment accounts over the last 10 years meant a major drag on performance, but an elevated Fed funds rate has led to yields over 4% in money market funds. Distressed investors looking for a reprieve in 2023 can choose to sit on a larger cash cushion and enjoy higher rates; the Fed currently projects rates to remain above 3% into 2025. At a minimum, all investors should have cash on hand for projected expenditures within the next 12 months.
The year 2022 will go down as a harsh reminder that no asset class is immune from difficult economic conditions. Inflation and the subsequent rate hikes affected every area of the market, but over time resilient markets bounce back. Higher interest rates offer enhanced yields for fixed income enthusiasts, while equities remain the best-equipped asset class in the face of rising rates and prices. Confirm your investment objectives, review your asset allocation, and investigate opportunities available in the current environment.
As always, reach out to your 1834 team with any questions.