By Jonathan Freeman, CFP®, CFA, CIMA®

The past few years have presented investors and financial industry professionals many firsts. The coronavirus crash of 2020 brought us seven of the 10 biggest one-day point losses in Dow Jones history, and shortly after that, anyone with a pool in their backyard could have been paid handsomely to fill it with oil instead of water.

Shockingly, soon after these events, the government’s record-setting stimulus program helped lead the S&P 500 to its largest 50-day rally in history. While all these firsts were taking place, the 10-year treasury yield also set a record closing low of 0.52% on Aug. 4, 2020, and negative-yielding debt around the world exceeded $17 trillion by early November.

Because of these recent events, which led to all-time-low interest rates, many investing rules of thumb based on historical norms have been called into question. If you do an online search for “is the 60/40 portfolio dead,” you will find countless articles on the topic, many of which argue that the concept of a portfolio balanced between stocks and bonds is, in fact, dead. Even though it is an exaggeration to call the 60/40 dead, portfolios in this low-rate environment could benefit from the integration of investment strategies that have often been overlooked.

You all heard of the phrase “risk-free return.” Funny enough, I recently heard someone refer to bonds as “return-free risk.” This is a constant topic of discussion for the Stonebridge Financial Group investment committee as we try to identify ways for our more conservative or retired clients to invest that can earn them a reasonable return without jeopardizing their retirement goals. As we navigate these difficult markets, we conceived new rules of thumb and thoughts on managing a balanced portfolio in an environment that has a good portion of the bond market earning less than the rate of inflation.

Due to low rates, investors may be tempted to substantially increase risk, whether through an increase in their stock allocation or a shift from investment-grade bonds into lower-quality and higher-yielding fixed income. Such changes become even more tempting when the Fed says it will support the credit markets through 2023 and when the government plans to spend trillions of dollars to stimulate the economy.

While stocks, despite high valuations, still appear to be more attractive investments than bonds, they can also lose much more in the event of a negative surprise, and junk bonds often have similar downside risk.

What if a recently retired investor wants to draw $50,000 per year from a million-dollar portfolio? It seems like a reasonable expectation (though some would argue that a 5% withdrawal rate is a bit too high), but it quickly becomes problematic if the portfolio drops by 30-40%. If $1,000,000 shrinks to $600,000, then the 5% withdrawal rate effectively increases to over 8%, which is unlikely to be sustainable over the course of a 30-year retirement.

What decisions can retired investors make given their desire to remain conservative in this low-rate environment? Assuming a typical expectation for longevity, one option could be to hold off on taking Social Security benefits. If interest rates were high and market valuations were low, it could make sense to take Social Security a little earlier, so that portfolio assets could enjoy what is likely to be substantial future growth.

However, we now have to assume that future growth rates for a balanced portfolio will be far below the historical averages. Accordingly, it may make more sense to take portfolio withdrawals while holding off on social security. If your full retirement age is 66 and you decide to wait until age 70 to get your benefit, you will get 132% of the full retirement age benefit because you delayed receiving it for 48 months.

Another decision many retired people face is whether to hold debt, such as mortgages, or to use their assets to pay them off. Given all-time low mortgage rates, it can be tempting to maintain a mortgage. Doing so could even be justified by the fact that interest rates may someday rise substantially higher than your current mortgage rate that is likely below 3%.

Perhaps this will be the case, but when the 10-year treasury rate hit around 3.25% in late 2018, it quickly became apparent that rising rates were negatively impacting the economy, which caused the Fed to reverse course as interest rates resumed their descent, culminating in an all-time low in August 2020.

Now that the government, corporations and individuals have added more leverage to their balance sheets, it is possible that it could be a very long time before we see anything close to “normal” interest rates. Accordingly, paying off 3% debt could still make more sense than earning a lower interest rate with investment-grade fixed income or taking on substantial interest rate or credit risk in an attempt to earn more than 3%.

One of the main concerns we have with bond investing today is that the income and diversification benefits they provided historically may no longer be available. As interest rates fell in 2019, the iShares 20+ Year Treasury Bond ETF (TLT) returned 14.93%. As rates fell further in 2020, this ETF earned an additional 17.92%.

Historically, as the economy enters into a recession and the stock market experiences a correction or bear market, rates fall and treasuries have strong returns that can offset some of the market’s downside. However, rates have already fallen so far that treasuries cannot provide the same returns going forward unless interest rates fall into negative territory.

Furthermore, we expect that correlations between investment-grade bonds and stocks may be positive going forward, since rising inflation and interest rates may have a negative impact on both asset classes at the same time. So, if investment-grade bonds don’t provide much diversification, what can investors do?

First, while cash is not going to keep up with inflation, we are in favor of having some cash on the sidelines for future spending needs. Doing so could help avoid potential losses and give investors the ability to opportunistically take advantage of market dislocations that will inevitably occur as rates and inflation rise, and we begin to see more volatility.

Second, we believe investors should strongly consider other diversifying asset classes like gold. Gold is a volatile asset class but is often a good diversifier during times of economy stress, and it may potentially help if monetary and fiscal policy end up creating a higher-than-expected rate of inflation.

Third, we believe that some moderate risk option strategies, such as selling cash-backed puts, can provide stronger returns than bonds without a substantial increase in risk. An investor selling a cash-backed put is paid an option premium in exchange for agreement to purchase the investment at a specific price and within a specific amount of time.

For example, on Friday, Feb. 12, shares of the iShares 20+ Year Treasury Bond ETF (TLT) were trading at $147.11 with an average yield to maturity of roughly 1.87%. An investor could sell an Aug. 20 $140 put for around $4.40 per share. This means that the investor is committed to purchase 100 shares of TLT at $140 ($14,000 in cash would need to be set aside) if it goes below $140 between the date of the put sale and Aug. 20.

This is $7.11 lower than the current trading price (4.8% downside protection vs. the current price of TLT), and the option premium of $4.40 is equal to roughly 3.14% of the $140 share price. This is a 3.14% yield in just a little over six months with 4.8% of downside protection. That is quite a bit less risky than buying TLT outright, and it pays a substantially higher yield.

While passive investing in both stock and bond indices has been a winning formula over the past decade, at Stonebridge, we believe that achieving reasonable returns with a moderate level of risk going forward will take far more creativity and diversification than it has in the recent past. We look forward to accepting the challenge of what is likely to be a difficult investment environment.

Securities offered through Triad Advisors, LLC, Member FINRA/SIPC.  Advisory services offered through Triad Hybrid Solutions, LLC, a registered investment advisor.  Stonebridge Financial Group, LLC and Triad Advisors, LLC are not affiliated. 


Jonathan FreemanAs one of the Directors of Stonebridge Financial Group, Jonathan’s goal is to help lead an organization that strives to provide the highest degree of client service, integrity, and professionalism. With disciplined investment strategies that emphasize risk-adjusted returns, cost, and tax efficiency, his objective is to help the individuals, families, corporations, and nonprofit organizations that he works with to achieve their financial goals.