Fixed Income in the Middle Term of One’s Career
In the middle years, it can make sense in some cases to look to gravitate towards fixed income more. Generally, this is prescribed as a sort of hedge, and while this might not be the best way to hedge against stock market drawdowns, as exiting the market during these times is a clearly better idea, if one is not looking to do that, then hedging with fixed income is at least better than no hedge at all.
The idea here is that, as one’s time horizons shrink, the risk of needing to cash out money invested today in the stock market becomes higher. If you have 40 years to save, and the long term upward bias of stock markets persist, as we assume they will, then it will take a reversal of this long term trend to really impact your long term results.
When this time frame is reduced to, say, 20 years, and it’s 40 year trends we’re using as a strategy to invest in, we no longer have that time frame to rely upon. The money we invested 20 years ago still does, but today’s money only has 20 years to work with, and we are less certain of the outcome of buy and hold strategies over this period.
Advisors don’t generally take this into account enough, nor do investors, but as the time frame shrinks, the likelihood of this strategy working diminishes. This requires us to change our strategy, not necessarily with money invested with enough time, but with money that is now being invested with shorter time horizons.
Stock markets most often, but not always, end up ahead over any given 20 year time frame, although we don’t just want to assume that since this has occurred in the past, these trends will continue. The likelihood that this will happen over 20 years is certainly less than it happening over 40 years though, so we must make adjustments to compensate for this added risk.
This is the real reason why adding a fixed income component to one’s portfolio can make sense at this point, provided we’re not managing our stock positions otherwise that is. That’s generally the case with people, and few investors are even up to considering timing their positions, even long term, so they do need some added protection here.
Fixed Income Investments Late in One’s Career
As we get closer to retirement, the window really shrinks, even to the point that we have to seriously consider why we are using a buy and hold investment strategy that requires a considerably longer time horizon to work generally than we have.
While advisors may recommend some adjustments here, putting more into bonds and pulling back from stocks, this tends to be nowhere near as conservative as it makes sense for it to be, and investors will generally still hold way too high of a proportion of their portfolio in stocks and not near enough in less risky fixed income investments.
A lot of investors may be in a position where they can ill afford taking their foot off the accelerator too much when it comes to backing off of the growth component of their savings, and this does factor into things for sure. More than anything though, we use formulas based upon age which are far too biased towards growth, even well into retirement.
If we will need to begin spending our savings in a few years, both the money we are saving now toward that goal and the money that we have saved throughout the years need much more protection from market drawdowns than was the case back when we had much more time.
On a random basis, which is the approach we tend to use, a 5 year time frame will not provide us much protection at all from drawdown risk, and this is at a point where we can ill afford such risks. We’ll be looking to convert our investments into more protected savings soon. How much we have in these few years is going to matter a lot, as it will set our income levels for the final period of our lives essentially.
Ideally though, what we’d be looking to do is to take the temperature of the market, where if it was in a bullish phase we’d be much more likely to stay the course with our growth component, and if things were more negative, we’d be more prone to move to fixed income, and in this case, perhaps move all of it there.
Given that this is not how most people manage their portfolios, and instead seek to use blanket strategies that operate outside of whatever realities that are in the market at the time, it is certainly wise to become much more conservative in the final years of one’s career, and not expose oneself to excessive risk at this point.
Fixed Income in Retirement
The reason we’ve saved all these years is that we can enjoy the benefits of seeing part or all of our income lost by retirement replaced by our savings. It is at this point that fixed income investments really shine, they are no longer primarily a hedge and are now the means by which we will extract the fruits of our labor.
If we just stay in growth investments in retirement, that can be done and can be done extremely well provided one actively manages such things, looking to be in stocks when the going is good and have one’s money elsewhere when the prospects of the stock market wanes.
Again, this is not what people tend to do though, so aside from this, this is not a time where we want to be taking on significant risks blindly, with no real plan on how to deal with these risks other than to sit back and lament on our fate when things turn badly.
This fate may include a significant loss of our savings, even selling investments at a loss to fuel our ongoing financial needs, or seeing one’s entire portfolio experience big losses where we may not even have the time to wait out the bear market and get even again.
In this environment, while fixed income investments are certainly more popular among those already retired, we may rightly wonder why anyone in this situation would expose themselves to the risks of the stock market, using long term strategies of buy and hold that just don’t work very well in the shorter time horizons they have due to their excessive risk on this time frame.
Once one is actively spending down one’s capital, one’s savings, then this is clearly a time that we should want to preserve them enough, and preserving capital is exactly what fixed income investments do.
We may even wonder why even those who have excess capital beyond what they need to be comfortable for the rest of their lives will even entertain ideas of taking on strategies with their excess that aren’t really suited to their time horizon.
Many people do not have enough though at this point, and while it may seem to make sense for them to gamble more, if we do so without managing the risks properly, this can lead to becoming considerably less wealthy if this doesn’t work out so well.
While devoting all of one’s capital to fixed income may not be the best strategy, taking on too much risk can be an even worse one, and while we may need to ramp up our rates of return at this point, we need to do so with an eye toward managing risk, and this is even more important now.
There are ways to do this, to seek to achieve the right balance between protecting part of our capital through fixed income and looking to grow the other part while at the same time managing these risks, which will involve market timing, and the fact that so many people don’t do this should not be a reason why we should not as well.
The best approach to balancing the income and growth portions of our portfolio, at any point in the game, should be a dynamic one anyway, although in our later years, we should strive to be a little more conservative and keep more in fixed income as a rule, and expose less of it to the market, even when these positions are actively managed.