Over the last several years, Sterneck Capital has engaged in an intense effort to determine how the current generation of retirees will be able to generate predictable, low volatility, income. Our thesis is that the portfolio structure Wall St. has been recommending for years, 60% equities (stocks) 40% fixed income (bonds), was not going to work in the future. In recent months, several large Wall St. firms have come around to our view. These firms have begun to inform their clients that the 60/40 retirement portfolio is likely dead, and a new portfolio mix is necessary to reach their goals. As you see above, firms such as Blackrock and FS Investments have recently published research in line with our long-term thesis.
For at least the last two decades a portfolio balanced between equities (stocks) and fixed income (bonds) has achieved most retiree’s goals. During periods of expansion, the stock market allowed retirees to grow capital while bonds provided cash flow. During recessions, the bonds provided stability and continued cash flow acting as a hedge against the drawdowns in equities. This portfolio worked remarkably well. However, as interest rates have been forced down, the portfolio mix that has been so useful no longer provides the same benefits. With interest rates at ½ of 1% on long-term debt these securities no longer provide cash flow. As an example, a $1,000,000 bond portfolio would have provided $60,000 in income in 2000 today that same portfolio would yield about $6,000 or 1/10th the 2000 amount.
To add insult to injury, the bonds also no longer provide the same stability in an equity drawdown. With rates so low, there is no room for the value of the bonds to appreciate in a negative economic scenario. Bonds now are unlikely to have much room to rise when stocks go down, hampering their ability to hedge the downside.
As these charts from BlackRock show, bond yields are at all-time lows while stock volatility is on the rise. Not a pretty sight for a retiree in a traditional asset allocation.
Unfortunately, despite the fact they have identified these issues neither FS nor BlackRock provides a satisfactory solution.
However, because we recognized this issue was coming some time ago, we have a compelling solution. The Sterneck solution takes advantage of several asset classes that are now available in structures that can be accessed by individual investors. Previously, these assets were only available to large institutions or in cost-prohibitive hedge fund formats.
Our solution focuses on generating returns from various risks, not assets. The volatility of the whole portfolio is very low because none of the risks are correlated to one another.
For example, we invest in insurance liked securities. The returns from these instruments are predicated on the occurrence of natural disasters in any given year. While some years may have disasters, and this asset may have lower returns in those years, the occurrence of those disasters will not be affected by the business cycle or interest rate cycle.
Another example is music royalties. In this investment we participate in a stream of royalties received every time a song in the library is used in a commercial setting. The library’s contents are classic, predictable, songs. While there may be some modest variation these songs generally play about the same number of times each year, regardless of the world’s economic or political gyrations.
These investments, along with other exposures unaffiliated with the economic or market cycle provide a portfolio with historic annual returns in the 5-7% range with bond-like volatility. This portfolio’s returns look a lot like a bond portfolio at the turn of the millennium in 2000.
Combining these investments with a thoughtful, diversified, low-cost, equity portfolio allows us to create a portfolio that acts as the 60/40 has for the previous generations of retirees.
If your current retirement, pre-retirement or target date portfolio is using only some combination of equities and fixed income it is time to for you to revisit your expectations on the future of that portfolio.
We would be happy to review your current portfolio and introduce you to our alternative to the “traditional 40” your retirement will thank you for making the effort.