Earlier this year, I discussed how a painful 2022 in the markets created a much brighter picture for long-term investors going forward.
Double-digit losses in both the stock and bond markets last year led to an important gain in future expected investment returns.
The improvement in bond yields has been especially impressive for investors who lived through close to 15 years of ultra-low yields, including periods when they didn’t even keep pace with inflation. During that time, many investors increased the equity allocation in their portfolio to make up for anemic bond returns—accepting more risk in search of higher returns from the stock market.
The strategy worked for those who could stomach periods of volatility and stay invested. Despite some setbacks, including the sharp but mercifully short pandemic bear market in 2020, stocks produced excellent returns from the financial crisis of 2008-09 through 2021.
Now, the picture has changed. Fixed-income securities are yielding nearly 5% and the question becomes: Is it time to move money from stocks to fixed income to take advantage of the higher yields and reduce risk?
Yields in the 5% range weren’t unusual before the financial crisis and, without predicting the future direction of interest rates, current action in the bond market suggests they will remain higher for longer than many economists had predicted.
In PWL Capital’s latest Financial Planning Assumptions, our estimate for expected annual bond returns jumped to 4.19% from 2.48% at the end of 2021. Our expected return for a broadly diversified 60/40 stock/bond portfolio rose to 5.75% from 4.97%.
As I noted earlier this year, in estimating returns, our research team doesn’t pretend to know what will happen in the markets in advance. Instead, they take the average of all possible return scenarios for a broadly diversified portfolio of publicly traded investments over a 30-year time horizon. Of course, returns in any given year can vary widely from the estimates.
This article argues that investors tempted by high yields should be careful not to short-circuit their long-term investment plan by forgoing higher expected returns offered by stocks.
“Stocks, which carry a risk premium to compensate for added volatility, will beat bonds over time, and bonds, which earn extra yield from taking term and credit risk, will beat secure, short-term vehicles such as GICs,” writes investment manager Tom Bradley.
Nevertheless, the emergence of higher interest rates marks an important shift. Changing your asset mix should never be done lightly or based on temporary economic, geopolitical or market developments. Instead, it should be executed as part of a comprehensive financial plan that considers your financial and personal situation, your investment knowledge, objectives and needs, your time horizon and your risk tolerance and capacity.
However, if the evolution of fixed-income yields allows you to achieve your goals while reducing the riskiness of your portfolio, it’s an option you should seriously consider with your investment advisor.
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