The start of the year has continued the already rough track for fixed income. Rising interest rates and elevated inflation shake the safety net that bonds have traditionally provided. And the pain becomes particularly unnerving for investors when the equity market experiences downside pressure simultaneously.
According to Financial Enhancement Groups Chief Investment Officer Adam Harter, “Bonds are primarily mathematical beasts. Much of that has to do with the nature of merely being legal contracts with an expiration date. Bonds mostly move based on a series of math equations. The overwhelming majority of investors inside retirement plans own bonds through a fund that tracks the most extensive bond index – the Barclays Aggregate Bond Index. It is of the utmost importance to understand that your risks are higher than they were a few short years ago.”
The critical term for the risk roller coaster this year is duration, which measures how sensitive bonds are to changes in interest rates. The duration equation tells us that if interest rates are up by a certain percentage, then our bonds would be down a certain percentage. As interest rates fell and duration increased, a peculiar situation occurred. The market is signaling a toxic relationship of lower rates but higher risks!
One group in the crosshairs of this dynamic are lifecycle and target-dated funds. Many fiduciary advisors abhor target-dated funds. The funds are typically indexed to the Barclays Aggregate index. As baby boomers age, uninformed investors are plowing money into funds aimed for near-term retirement. The lifecycle fund industry reduces equities and increases bonds as folks age. This increase in bonds and a decrease in stocks occurs regardless of current economic and market realities.
Thus far, the battle of the bonds in 2022 has continued from 2021 due to the underlying levels of interest rates and rising inflation. With the fed guaranteeing interest rate hikes and stating their intention to release securities from their balance sheet in June, we could see continued harm to bond portfolios. However, an important note is that bonds still play an essential role in your retirement portfolio – even if your access is limited to the primary aggregate bond index. Even though our firm has owned fewer bonds over the past several months for some of the reasons mentioned above, this is not a blanket statement that fewer bonds are in order. But it will still be time to pay very close attention as to how that exposure is garnered. Always know what you own, why you own it right now, and what you expect it to do for your portfolio. There are also alternatives to consider when looking at protecting your downside.
If you are managing your retirement risk independently, or you are with a financial team that doesn’t pay attention to all your life’s critical elements, give FEG a call. The FEG team will help reduce financial regrets. And we have a team of effective advisors that are prepared to guide you appropriately on your Life After Work journey.