We've seen this scary movie before. In 2000 and then again in 2008: The market starts to crater and retirees and those on retirement's doorstep start to panic as they watch their nest egg decline in value and along with it their standard of living.
On the one hand, they want/need to stay investing in stocks. But on the other hand, they want to protect their principal. What to do? What asset allocation do advisers suggest? What sectors/stocks offer downside protection with upside potential? Here's what advisers had to say.
Of course, it should go without saying but it also bears repeating that the key to any investment strategy, at any point of the investment life cycle, is in developing a specific plan and following it, period, says Christian Hyldahl, president and chief investment officer of Varium Investment Partners.
Once you've done that, preferably from Hyldahl's perspective, with the help of an investment adviser, you can assess the current situation.
"When was the last time the stock market hit all-time highs as interest rates were rising?" asked Hyldahl. "What did the stock market do as rates rose from a near-zero level? There are no -- or at best, few -- examples to look to in the past for our current situation."
Thus, he says, the best advice then is to stick to the plan you developed working with your adviser and his/her investment specialist/expert. That plan should include an asset allocation for your portfolio that can meet your minimum return requirement based on assumptions that are extremely conservative.
So, what then are Hyldahl's current recommendations/strategies for retirees?
Throw Out Traditional Investment Dogma
"Growth-oriented portfolios may best be allocated 80/20 for the next three years, 80% fixed-income and 20% equity," he said. "Balanced, traditionally 50/50 portfolios, may be 80% fixed-income and 20% equity as well."
Asset allocation, from Hyldahl's point of view, is not a static practice. "Keeping in mind tax consequences, allocations should be changed to reflect current realities," he said. "Unfortunately, in my experience, advisers do a pretty horrible job of making these adjustments, either because they do not have the skill, or they do not have the infrastructure. It is the basic building block of any investment strategy and one that needs to be dynamic in order to both protect and grow clients' assets."
Mean Reversion Is a Real Thing
For your allocation to equities, Hyldahl recommends focusing on contrarian areas that have not done well or as well as others. "Mean reversion is a real thing," he says.
What else can be done?
First and foremost, find great portfolio managers with expertise and focus to invest in specific growth/value strategies that then make educated and informed investments in sectors and industries within of the market. "Make sure these managers have no more than 45 companies in their portfolio, less than 25% turnover, good risk-adjusted returns," he said. "You pay your adviser to do this for you. If they don't or can't, get a new adviser."
Second, focus on value-oriented equities that pay a dividend, said Hyldahl. "Start selling U.S. equities in favor of international developed markets that have not performed well," he said. "Selectively, and on a country-by-country basis, look to emerging markets equities."
Hyldahl would also look to sectors and industries that will do well in a rising rate environment. "Some growth stocks should continue to do well, though I do not think it will be in tech," he said. "Likely, underleveraged industrials and banks would be good areas to do a deeper dive. Look for companies that have not fared as well but have a catalyst for change. That was a formula that worked well for me."
As for the fixed-income portion of your portfolio, Hyldahl recommends using individual issues, not mutual funds or ETFs. "Find a good manager that knows how to find value on the yield curve and can effectively source those issues without commission drag," he said. "Take a fresh look at segments of the market you normally would not, perhaps taxable offers a better after-tax return than munis, some selective high yield issues, for high grade, try moving up or down in quality as defined by ratings."
Look too, he said, for mispricing in the border areas between ratings, focusing on the lower end of investment grade -- three to five years out given the flatness of the yield curve. "Avoid junk as it tends to be correlated to oil, which is in a bear market," he said.
Look also at after-tax returns and invest in areas that might have been neglected. "Don't default to munis just because that's what you have done for taxable accounts," said Hyldahl.
And look for cheaper areas of the curve. "Right now, munis, 10- to 13-year paper has been attractive, he said. "Even govies are more attractive.
(What's a govie? According to Investopedia, it's a government bond -- is a debt security issued by a government to support government spending. Federal government bonds in the United States include savings bonds, Treasury bonds and Treasury inflation-protected securities (TIPS).)
Also, plan to go long in the event of a slow-down in the economy, he said. "Zero coupon bonds are a great place to be if we go into recession," Hyldahl said. "(It) goes with the dynamic asset allocation theme. Sometimes your growth assets in a tough market are your 'safe' investments, like bonds."
Consider too making your equities work harder by using a covered call strategy.
Also use low-cost portfolio protection strategies. At his firm, Hyldahl prefers to use longer dated options on the VIX itself when volatility is low and go the opposite way when volatility spikes for an extended period. "This has been a one way bet for quite some time but is a very cheap insurance policy for rapid downward movements in the market that spike volatility," he said. "This insurance might cost 1% or slightly more of your portfolio, but if the market corrects sharply, you will benefit immensely. If they market contuse to rise, then you benefit as well. Timing the market is impossible, being ready for what it throws at you is not."
Another Point of View
For his part, Case Eichenberger, a senior client portfolio manager with CLS Investments acknowledged that retirees and near-retirees might be fearful and anxious at the moment. "October was the worst month for U.S. stocks since September 2011," he said. So far in 2018, we have experienced two separate 10% drawdowns in equity markets. This volatility is likely causing current and prospective retirees to rethink their investment strategies."
But there are ways, he said, for them to protect their nest eggs, while continuing to participate in the stock market and its eventual gains. His advice:
Hold a Diversified Portfolio of Global Stocks and Bonds
Even with interest rates rising in the U.S., bonds help hedge equity risk and should make up a portion of a balanced account, said Eichenberger. "The old truism holds today: 'Have enough bonds not to get scared out of stocks and enough stocks not to get scared out of retiring,'" he said.
If, however, investors will need money from their investments in the next five years, they should withdraw those funds out of stocks and put them in a safe place, such as cash, said Eichenberger. "Investing for the short-term is not much different from gambling," he said.
Maintain a Long-Term Outlook
Even in retirement, most investors need to have a portion of their portfolios in equities to continue to fund retirement and try to outpace inflation, said Eichenberger. "Equity investors should maintain a long-term outlook of at least five years to help avoid bad decisions, such as getting scared out of the stock market and missing the inevitable recovery in stocks," he said.
After a diversified portfolio of stocks and bonds is achieved, Eichenberger said, investors should ask their money managers to dig deeper for assets that may help preserve their accounts.
Eichenberger said CLS Investments manages a strategy that seeks to help investors limit their exposure to large equity declines of 20% or more. "We invest in global equities when markets are rising -- like they were in 2017 -- to allow investors to participate in positive gains," he said. "In times of abnormal volatility, we seek to limit large losses by investing portions of the portfolio in low-beta/minimum-volatility stocks and cash, while avoiding high-beta/high-volatility stocks that may experience large drawdowns."
The result, said Eichenberger, is a portfolio that will employ a rules-based strategy that slowly reduces risk in times of stress but still allows participation in the eventual market recovery.
What's Your Risk Tolerance?
The end allocation to these types of strategies, as well as broad stocks and bonds, should be determined by an investor's ability, willingness, and need to take on risk, said Eichenberger.
The ability to take on risk is typically defined by an investor's time horizon, he said. "The longer they have to invest, the more ability they have to endure stock market gyrations," said Eichenberger. "The shorter their ability, the less they should have invested in stocks."
Their willingness is simply their risk tolerance, said Eichenberger. "An investor could be retired but like the idea of long-term capital growth and participating in the stock market," he said.
The need to take risk, he said, is defined by whether they have met their retirement goals laid in place with the help of a qualified planner. "With these strategies in mind, investors can work with their money managers to determine an appropriate amount of risk to budget within their portfolios," he said. "This will enable them to protect their nest eggs, while continuing to participate in the stock market, even during times of market stress."
Remember: It's never too late -- or too early -- to plan and invest for the retirement you deserve. Get more information and a free trial subscription to Retirement Daily to learn more about saving for and living in retirement. Got questions about money, retirement and/or investments? Email Robert.Powell@TheStreet.com.
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