I have written a LOT about this recently, but it’s a point worth repeating and, in my mind, the biggest story of the past few years. Bonds are offering the worst prospects and risk/return profile in history. With rates at near-historic lows, spreads coming in due to active Fed buying programs and Fed pronouncements that they have a zero bound on rates, there is almost NO current yield and NO upside left for bonds. This is not my opinion; it is math!
So, be prepared for bond returns over the respective time horizons to be bounded by current yields. For example, a 10-year treasury bond today has a duration of about 9.6 years, so over the next 9 years, regardless of what interest rates do, you can expect a total return equal to the current yield of about 0.86%! A dismal prospect for sure! Corporate bonds, with an added credit spread of 1.16%, offer a slightly better prospect totaling a 2.02% total return. Factor in inflation of about 2% and you are looking at a 0% real return over the time horizon.
This situation is not too bad for investors with a very long time horizon, like most young individuals, since they are likely less exposed to the bond market anyway, being more focused on equity markets that offer more risk and the potential for more returns.
But, what is a pre-retirement and in-retirement investor to do? There are a few things. First, if you are in the pre-retirement phase, depend less on investment returns to fund your retirement and save MORE! Though this strategy has nothing to do with investing, it has everything to do with investment planning for retirement.
Also, unless you can’t afford any risk, adding diversified risks to your investment portfolio is a prudent approach. This would include adding a mix of other fixed income sectors including high yield bonds (“junk” bonds), foreign and emerging market bonds, bank loans, and preferred stocks. Also, some decent diversified exposures in high dividend and dividend growth stocks offers the potential for higher yields as well as the potential for growth. Arguably, one of the reasons equities have a strong bid is the prospective relative value equities offer compared to bonds!
This year has borne out the advantage of a diversified mix between high dividend and dividend growth stocks given the differing YTD return profiles; high dividend (DVY) down -9% compared to dividend growth (VIG) up +11%! Though dividend growth in 2020 so far paid a lower yield of 1.8% compared to the high dividend yield of 4.3%, the total return of dividend growth more than made up for the yield deficit.