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What Can Retirees Expect From Bonds?

What Can Retirees Expect From Bonds?

Christine Benz: Hi, I'm Christine Benz for Morningstar. What do today's low bond yields mean for retirement planning? Joining me to discuss that topic is David Blanchett. He's head of retirement research for Morningstar Investment Management. David, thank you so much for being here.

David Blanchett: Thanks for having me.

Benz: Let's discuss this issue of really low bond yields. What does it say about the role of bonds in a portfolio? I think some investors might be inclined to almost forget about them because it's really hard to see what the value is. How should investors think about bonds from a portfolio standpoint today?

Blanchett: First, it's incredibly depressing, right? You've got yields on 10-year bonds under 1%, and who knows how long they'll be there. And to your point, someone might say, "Well, David, I don't want to invest in bonds because they have a lower return." Well, I would argue that, in theory, the return on stocks is the return on bonds plus some kind of equity risk premium. And so I think a lot of investors that have to achieve a certain rate of return, they might be less interested in owning bonds, but bonds have always been that safe part of a portfolio. I'm hesitant to tell someone to move too much out of bonds to reach for return because they really are important to ensuring the diversification over the long haul.

Benz: How about that at the other end of the spectrum, someone who might say, "Well, why not just cash?" Given how minimal that yield differential is today, is that reasonable to maybe think about just getting out of bonds and moving those funds into cash instead?

Blanchett: Yeah, I could see an argument for lessening duration. There isn't a whole lot of premium these days for going way out on the duration curve with long maturity bonds. But if you own cash, you're going to earn a 0% rate of return. And that's before, you won't get taxed on that, but that's before fees and inflation. And so if own cash, you are virtually guaranteed to earn less than inflation. If you own bonds, you probably will, but it's not for certain. For me, I think that, to your question, owning cash is maybe a little bit more attractive than it was before, but I'm kind of a boring long-term strategic investor, so I would say that you still need a healthy slug of bonds in any balanced allocation.

Benz: Let's discuss this from a portfolio plan perspective. If I'm planning out my retirement or even my years until retirement, and I have some sort of bond allocation, what's a reasonable return assumption? I know that you think it's a huge mistake to just extrapolate from past history in terms of bond returns. That people really need to be quite conservative, right?

Blanchett: Yeah. I think that a lot of financial planners and a lot of financial-planning tools, they use historical long-term averages as their return assumptions. The historical long-term average return on 10-year government bonds is about a little over 4.5%. That's about 4% higher than they are today. And so I think that, if you're watching this and you are a financial planner or you've done a financial plan, you've got to first ask yourself, "Are my assumptions reasonable?" And I don't know that returns will stay this low forever. I might argue they might. But I think it's important when you're modeling returns, they're reasonable. And so I don't think for 10-year government bonds, I think 1% or 2% for the next 10 years is pretty reasonable. For aggregate, maybe 3% or 4%, but those are really low numbers. And once you tack on volatility drain and fees and taxes, you are looking at a realized return that's pretty close to zero or negative.

Benz: Let's talk about the implications for how someone actually thinks about their retirement plan, specifically talking about withdrawal rates. I know that you and some of your co-researchers have been saying that investors really ought to think about ratcheting down their withdrawal rate assumptions. Can you discuss what role low yields play in that overall guidance?

Blanchett: Sure. It's kind of funny, I wrote some research with Wade Pfau and Michael Finke, I don't know, five or six years ago. And we talked about this idea that a lot of the historical research, almost all of it at the time on safe withdrawal rates was based upon historical long-term averages. And we're like, "Hey, what if we have low interest rates for a while?" And people said, "Ah, this is just a short-term anomaly, things will get back up soon." Well, we're actually lower today than we were five or six years ago. And I think that what it really requires is revisiting your assumptions. And if you rerun the historical estimates that came out with a 4% safe withdrawal rate, you'd get a withdrawal rate that's less than 3% today.

Now, I actually think that 4% is fine for most people because most people have Social Security retirement benefits. They can spend less than they need to, but return is one of the biggest drivers of what you can spend from your portfolio. And if yields stay low for a long time, I think it's going to have a pretty huge impact on both people who are accumulating for retirement but also who are taking down money to spend in retirement.

Benz: And you made the point to me that where yields are today affects a lot of other aspects of retirement planning as well. Let's talk about how that might inform someone's thinking with respect to Social Security filing. How do the two fit together?

Blanchett: Social Security is kind of an anomaly in the world of guaranteed income where the payout doesn't change based upon prevailing yields. And so, other forms of guaranteed income like private annuities, they actually become more attractive, relatively speaking, as interest rates fall. There's this thing called "mortality credits." They're actually kind of a better way to fund retirement when interest rates are low. The interesting thing about Social Security: When interest rates fall, the benefits don't fall as well. And so it was a great thing, let's just say, a few years ago, now it's the greatest thing since sliced bread. And so, if you can afford to do so, delaying Social Security is, without a doubt, the most attractive way to fund retirement today.

Benz: Because you enlarge your eventual benefit.

Blanchett: Yeah. Again, to me, it's not an investment, but you earn a rate of return by delaying claiming Social Security. And when you delay claiming Social Security, you're actually earning an interest rate that's probably north of 6% or 7%, and you just cannot get that today in any kind of market. And when you tack on the survivor benefits, in fact, it's attractively taxed, it's linked to inflation. It's kind of the relative value of Social Security today versus anything else is so much larger because interest rates are so low.

Benz: And you referenced annuities, David, but let's discuss that because I sometimes hear people say, "Well, interest rates are so low, why would I lock in an annuity now?" But you just said that actually it's not as unattractive as it might seem. Can you talk us through that?

Blanchett: Sure. The key is relatively speaking. If interest rates are low, the payout on annuities are lower. They are linked to the same bonds that you would buy in your portfolio. But if you buy an annuity, you're also buying this thing called "mortality credits." When I'm using the word "annuity," I'm focused on income for life, not an accumulation vehicle. I'm focused on a product that creates income for you in retirement. And again, there's two parts of that payout. One is what's called "mortality credits" and one is what's called the "interest rate." Well, as interest rates have moved to zero, you still get the value of mortality credits when it comes to buying an annuity, so it's definitely true that interest rates have affected the payout rates on annuities, but they're actually kind of a more attractive investment today versus fixed income because you still earn that benefit of mortality risk pooling.

Benz: David, big topic. Thank you so much for being here to discuss it with us.

Blanchett: Sure thing.

Benz: Thanks for watching. I'm Christine Benz for

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About the Authors

David Blanchett

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David M. Blanchett, Ph.D., CFA, CFP®, is head of retirement research for Morningstar’s Investment Management group. In this role, he works to enhance the group’s consulting and investment services. He conducts research primarily in the areas of financial and tax planning, annuities, and retirement plans. Blanchett also serves as the chairman of the Advice Methodologies subcommittee, which is the group responsible for developing and maintaining all methodologies relating to wealth forecasting, general financial planning, automated investment selection, and portfolio assignment for Investment Management. Before joining Morningstar in 2011, he was director of consulting and investment research for Unified Trust Company’s retirement plan consulting group.

Blanchett’s research has been published in a variety of academic and industry journals, such as Financial Analysts Journal, Journal of Financial Planning, The Journal of Portfolio Management, Journal of Retirement, and The Journal of Wealth Management. He has also been featured in a variety of media outlets and publications, including InvestmentNews, MarketWatch, Money, The New York Times, PLANSPONSOR, and The Wall Street Journal. His research has won a number of awards, most recently the Journal of Financial Planning’s 2014 and 2015 Montgomery-Warschauer Awards, the Financial Analysts Journal 2015 Graham & Dodd Scroll Award, and the CFP Board Center for Financial Planning 2017 Academic Research Colloquium Best Investments Paper Award.

In 2014, InvestmentNews included him in their inaugural 40 under 40 list as a “visionary” for the financial planning industry, and in 2014, Money named him one of the brightest minds in retirement planning. He is a RetireMentor for MarketWatch and an expert retirement panelist for The Wall Street Journal. Blanchett is also on the executive committee for the Defined Contribution Institutional Investment Association (DCIIA) and serves on the editorial boards of Morningstar Magazine and the Journal of Retirement.

Blanchett holds a bachelor’s degree in finance and economics from the University of Kentucky, a master’s degree in financial services from The American College, a master’s degree in business administration from the University of Chicago Booth School of Business, and a doctorate in personal financial planning from Texas Tech University. Blanchett holds the Chartered Financial Analyst®, Certified Financial Planner™, Chartered Life Underwriter (CLU®), Chartered Financial Consultant (ChFC), and Accredited Investment Fiduciary Analyst™ designations.

Christine Benz

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Christine Benz is director of personal finance and retirement planning for Morningstar, Inc. In that role, she focuses on retirement and portfolio planning for individual investors. She also co-hosts a podcast for Morningstar, The Long View, which features in-depth interviews with thought leaders in investing and personal finance.

Benz joined Morningstar in 1993. Before assuming her current role she served as a mutual fund analyst and headed up Morningstar’s team of fund researchers in the U.S. She also served as editor of Morningstar Mutual Funds and Morningstar FundInvestor.

She is a frequent public speaker and is widely quoted in the media, including The New York Times, The Wall Street Journal, Barron’s, CNBC, and PBS. In 2020, Barron’s named her to its inaugural list of the 100 most influential women in finance; she appeared on the 2021 list as well. In 2021, Barron’s named her as one of the 10 most influential women in wealth management.

She holds a bachelor’s degree in political science and Russian language from the University of Illinois at Urbana-Champaign.

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