Perhaps 99% of all investment discussions revolve around risk control with scant attention paid to inflation risk and risk of lost opportunity costs. Most investors seem to be fearful about stock market drawdowns and position their portfolios with high exposure to fixed income securities to moderate the daily ups and downs of the stock market.
The idea of a 60/40 portfolio was born in 1952 when life expectancy was 68 years of age. Still an adopted approach in investment circles today, it has outlived its usefulness because many retirees will live into their 80’s and 90’s. In fact, the fastest growing segment of the population are people over the age of 85. This fast-growing age group has been dubbed “super agers.”
It goes without saying that longer life spans require more money to maintain one’s living standard throughout retirement. But many retirees have not saved enough or have not invested wisely.
Target Date portfolios pushed onto retirees by the major advisory firms use the Rule of 100 to determine asset allocation for the typical retiree. This Rule works as follows: 100 minus one’s age at 65 at the start of retirement dictates that 35% of assets should be invested in stocks with the balance of 65% invested in fixed income securities. The annual allocation to fixed income assets based on one’s birthday is programmed to rise by one percentage point each year after age 65. Thus, a 75 year-old retiree would hold 75% of their overall portfolio in fixed income assets in a Target Date portfolio.
The National Institute on Retirement Security estimates that more than 50% of retired people cannot maintain their standard of living throughout retirement. This writer encountered a hands-on situation some years ago while living on a South Carolina barrier island. Island residents referred to the Seabrook Island as “paradise” because it offered golf, tennis, horseback riding, ocean and fine dining.
As part of a gourmet dining group entwined with five other couples back then, three eventually moved away from “paradise” by inferring that they were downsizing their homes. What they didn’t say was that they had run out of money to live there.
The preponderance of advisers recommends an asset mix heavily skewed toward fixed income investments for retirees which borders on malpractice in the eyes of this writer. They assume that retirees will need all their money in the next year, but this is far from the case. Retirement plans are built with the assumption that yearly withdrawal rates will typically be 4 or 5%. Thus, the bulk of assets will remain untouched for years.
What goes ignored is the real wealth creating mechanism of the US stock market, the greatest money-making machine in the world in the view of this writer. Stocks over time have created a huge gain in real wealth whereas bonds historically have produced very modest gains or even severe real losses over long periods.
Investors may be surprised to learn that individuals who held a portfolio of long-term bonds have not made money in real terms since 2006. During 2007-2025, long government bonds returned 54% according to the Stern Business School at NYU. Meanwhile, the Consumer Price Index increased 56% during the same period. The S&P 500 crushed the CPI by returning 563% while producing a massive gain in purchasing power along the way.
If we go back even further in time, it can be observed that bonds do little to help people in retirement. The period of 1941-1980, a period of runaway inflation in the US speaks to this point. In 1941, interest rates and inflation were historically low. The CPI advanced less than 1% and long government bonds offered an average yield of 2.5% in this year. By 1980, the CPI shot up to 13.5% and long bond yields had risen to 12% before peaking at 15.8% in early 1981. During this 40-year period, a $1 dollar investment in bonds grew to just $1.74 while it took $5.10 to purchase what $1 could buy in 1940 according to the Stern Business School. Thus, investors forfeited more than 60% of their purchasing power by owning bonds.
And this outcome was even worse for the well-to-do because tax exempt accounts were not introduced until the passage of Employee Retirement Income Security Act (ERISA) of 1974. From 1944 through 1963, the highest marginal tax rate exceeded 90%. However, on the brighter side, $1 dollar invested in the S&P 500 would have grown to $73 which produced a prodigious gain in purchasing power.
Over the past 85 years, bond returns have failed to keep pace inflation in 70 of 85 years. There has never been a good time to own bonds in the opinion of this writer, especially now. It took 225 years for the US to amass 5 trillion dollars of national debt and just 25 years to add an additional $35 trillion dollars of debt due to heavy deficit spending.
Bond investors are unknowingly sitting on a time bomb because right now the supply and demand for government debt are in balance. The US is adding $2 trillion of debt each year through deficit spending with no end in sight. At some point, demand will fail to meet supply and interest rates will certainly rise.
The evidence at hand shows that bonds get decimated by inflation, but stocks have historically beat the rise in the price level by quantum amounts over time. Given the foregoing, investors may want to adjust their portfolios before it’s too late.
