Your 401(k) Is Falling Behind. Here’s What You Should Do.
Nov 17, 2023
How to know when
it is time to take your portfolio off autopilot
The investing strategy millions of Americans rely on to secure a
good life in retirement hasn’t
worked lately. They should probably stick with it anyway.
Most
people keep their 401(k) on autopilot by investing in a diversified portfolio
of stocks and bonds. Faith in this
approach has been shaken by three years of losses in the bond market.
It is being further shaken now.
With yields on government bonds around 5%, some are thinking of taking money
out of stocks to
put it into bonds.
As tempting as it might be to meddle with your
investments, history suggests most investors have a lousy record of timing the
market. Financial advisers say the majority of Americans should stick to
time-tested advice and simply do nothing.
“Just because your strategy has a
bad year or two doesn’t mean you should make changes,” said William Bernstein,
a financial adviser and author of “The Four Pillars of Investing.” “Even the
best strategies are going to have a bad year now and again, so the best thing
you can do is pick an investment mix that’s reasonable and stick with it.”
Investors’ desire to take their
nest eggs off autopilot is understandable. In 2022, a balanced portfolio evenly
split between stocks and bonds lost 15.5%. This year, a 50/50 portfolio is up
about 7.9%, even as the S&P 500 index has risen 16.6%.
Meddling with your 401(k) is a major step that can leave investors
worse off than if they stick with a balanced portfolio. Bonds have performed
poorly in recent years, but both bonds and stocks still play a vital role in
building retirement security.
Stick with target-date funds
Americans
have funneled a large percentage of their 401(k) savings into target-date
funds, which shift from stocks to bonds as retirement draws nearer. Designed to
give investors a set-it-and-forget-it approach, they are the default options in
many plans.
These
funds have struggled recently. Portfolios for people planning to retire in 2040
fell 17.3% in 2022 before rising 3.7% through Oct. 31, even as the S&P 500
gained 10.7% including dividends over that time.
Funds
that combine stocks and bonds tend to earn steadier returns than those that
invest in a single asset class, such as stocks, although they can cost slightly
more. That makes it easier for people to stick with stocks, which have greater
growth potential than bonds, in bad markets, said Amy Arnott, a portfolio
strategist at Morningstar and
co-author of the report.
“Target-date fund investors leave their investments alone, which is
the best thing to do if you’re trying to build long-term wealth,” Arnott said.
In
2022, 2% of target-date fund investors traded their holdings, versus 11% of
other 401(k) investors, according to Vanguard. Studies have found that
investors who trade frequently are more likely to buy after rallies push prices
up and sell when markets are depressed and their holdings are beaten down.
Target-date fund investors have kept all but 0.46% of the 6.44%
average annual gain their funds have earned over the past decade. In contrast,
investors in a broad array of funds, including those specializing in stocks and
municipal bonds, forfeited 1.7% of their annual gains, Morningstar found.
Don’t give up on bonds
In
recent decades, bond prices have often gone up when stocks fell. This is one
reason why they are an important
part of a diversified portfolio.
But
when inflation heated up in 2022, stocks and bonds fell in unison. The S&P
500 lost 18.1%, with dividends reinvested, while the widely tracked Bloomberg
U.S. Aggregate bond index declined 13%.
If
inflation persists, some financial professionals predict an era in which
simultaneous stock and bond declines are more common. As a result, they argue,
building a nest egg by rebalancing a mix of stocks and bonds may not work as
well as it has in the past.
Bonds are still worth holding, said Bernstein.
For
one thing, it is impossible to predict what inflation or interest rates will
do. And over the long-time horizons many retirement investors have, bonds are
still likely to provide some protection when stocks fall, he said.
Now is
almost the worst time for investors to sell bond funds, said Roger Aliaga-Diaz,
global head of portfolio construction at Vanguard. Investors who do so will
lock in their losses just as bonds are producing higher income streams, he
said. Over time, the fatter yields will result in higher total returns, making
up for the losses of the past few years, he said.
The more investors earn on bonds, the less stocks have to return
for them to meet their retirement goals, said Brendan Mullooly, an adviser in
Wall Township, N.J.
“Bond
yields’ rising has inflicted short-term pain on investors but it will make the
retirement income math much easier moving forward,” he said.
Consider TIPS
At
4.6%, the yield on the benchmark 10-year Treasury is higher than it has been in
more than 15 years.
But
after accounting for the inflation the bond market expects over the coming
decade, the real yield is just above 2%. If inflation exceeds expectations, it
will erode the value of the bond income.
Until
the risk of higher inflation subsides, retirees should consider two strategies,
Bernstein said.
One is
to invest in short-term Treasury bonds, with maturities of up to about three
years. Since their prices are less sensitive to changes in interest rates,
funds that invest in short-term U.S. government bonds have
lost 1.68% annualized over the past three years, versus
a 16.57% annualized decline for long-term U.S. government bond
funds over the same period, according to Morningstar.
Another
strategy is to buy TIPS, or Treasury inflation-protected securities, of varying
maturities.
In the
beginning of 2022, the real yield on the 10-year TIPS was negative. Today,
investors can lock-in a 2.3% yield. If investors hold TIPS to maturity, they
are guaranteed that annualized return, because the bond’s principal adjusts for
inflation.
Allan
Roth, an adviser in Colorado Springs, Colo., recently built a $1 million ladder
of individual TIPS that mature at intervals over 30 years. The principal on the
bonds that mature each year plus the income payments on longer-term holdings
will provide inflation-adjusted cash equal to about $45,000 a year in today’s
dollars, he said.
The
ladder allows him to spend 4.5% of his $1 million investment each year,
exceeding the 4% spending rate that’s considered safe for new retirees with a
30-year horizon. The TIPS ladder will be depleted after 30 years, while the
stock-and-bond portfolio may not be.
Roth
recommends capping TIPS exposure at 30% of the bond portion of a
portfolio. Two independent sites that offer advice on making a ladder are tipsladder.com and EyeBonds.info.
Source: Wall Street Journal