News that the Federal Reserve could begin phasing out its bond-buying program later this year shouldn’t affect young workers’ retirement savings strategy, but those nearing retirement may want to move away from fixed-income investment vehicles. , including long-term bonds, advisers say.
Federal Reserve Chair Jerome Powell, speaking at the central bank’s annual symposium in Jackson Hole, Wyo., last week, said the Fed is considering a plan that would begin phasing out $120 billion in monthly Treasury bill purchases and mortgage-backed securities, probably as early as this fall. The purchases were launched early in the pandemic to keep interest rates low.
It is uncertain when the winding down will begin and how quickly the Fed will scale back its asset purchases. But Christine Armstrong, executive director of wealth management at the Armstrong Group at
said winding down could start as early as September, earlier than most economic analysts expect, potentially leading to a 10% to 15% drop in the stock market.
Factors such as the rapid spread of the Delta strain of the coronavirus and the expiration of federal unemployment benefits for those affected by Covid-19 could also contribute to a stock market slump, Armstrong said. While no one knows when the Fed will raise interest rates from their historic lows, tapering is the “first step” toward rate hikes, so fixed-rate bonds are unattractive right now, she says.
“Absolutely, we expect a decline this fall, which would be normal in the course of a mainstream market,” Armstrong said. “We don’t see it as particularly troubling or anything like that.”
Investors faced a taper tantrum in 2013, when then-Fed Chairman Ben Bernanke surprised markets by announcing that the central bank would begin phasing out its bond-buying program that had begun during the financial crisis. The run-down meant there would be less demand for government bonds, so bond investors responded by selling bonds, pushing yields higher while bond values fell. From May 1 to the end of 2013, the yield on 10-year Treasuries rose sharply from 1.66% to 3.04%, while many bonds closed the year in the red.
If a similar situation arises this fall, Armstrong says, fixed-income bond funds and similar investment vehicles favored by low-risk retirement savers could suffer. “Bonds will fall out of favor,” she says, “so with all the bonds you own, you’re going to get huge headwinds. It will be difficult to make money in bonds.”
Although the stock market fell during the 2013 taper tantrum, the dip was “short and fast,” said Ben Barzideh, wealth advisor at Piershale Financial Group, and stocks recovered quickly. For younger workers, who typically have the majority of their 401(k) or other retirement savings in stock, the potential for another downturn in the market from phasing out is no reason to adjust their savings strategy, he says.
“Younger people are more isolated,” says Barzideh.
For older workers, says Barzideh, bonds remain a necessary part of their retirement portfolio as protection against a sharp market decline. It’s difficult to predict the Fed’s timetable, he says, but he has seen the phasing out of asset purchases at about $15 billion a month likely beginning in December or January, adding that a major taper tantrum is unlikely as the Fed “has done a relatively good job”. from managing expectations and creating the scenery so people know it’s coming.”
“Certainly, we would never advise older people to reduce their bond holdings because of this,” he says. “Maybe they want to phase out some of their long-term bonds and add a little more to medium or even short-term bonds if bonds are hit pretty hard.
“Bonds can do well in periods when interest rates are rising, whether it’s because of the rundown or the Fed raising rates, but it’s definitely a headwind.”
Rather than investing in traditional fixed-income bonds, he says, older workers might want to consider a Treasury Inflation-Protected Securities, or TIPS. The principal of TIPS increases with inflation, as measured by the consumer price index.
As for equities, Armstrong said retirement savers should consider banks and other financial services companies, whose margins on loan products would improve if interest rates eventually rose.
Daniel Milan, managing partner of Cornerstone Financial Services, said older workers seeking lower-risk investment vehicles should consider floating-rate funds, which have a floating rate tied to a benchmark rate.
“We really don’t want customers in traditional fixed-income bonds, be it corporate bonds or government bonds, because if interest rates go up, the market value of those bonds will fall,” Milan said.
He also likes blue-chip stocks that pay dividends and real estate investment trusts, which can serve as hedges against high inflation rates. He likes large cap stocks like
(KO) that pay reliable dividends.
“If you’re going to take the equity route to generate income rather than the traditional fixed income route, you want them to be safe,” says Milan. “You are looking for blue chips, or Dividend Aristocrats – companies that have consistently paid dividends for over 25 years. We are specifically targeting companies that have historically increased their annual dividends at a rate that has outperformed inflation.”
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