Is This The Hardest Time In History To Retire?

If you’re starting to plan for retirement or even if you’ve already retired, this is the article for you.  Knowing what you’re in for during your retirement investing lifetime is essential for you to achieve success, and unfortunately, it’s not easy today.

Let’s start with fixed income. Many people invest more or even most of their money in bonds in retirement thinking they’re safer and will help them avoid losses in stocks that will cause them to run out of money.  Historically, bonds have had decent returns; from January 1926 through June 2021, Five-Year Treasury Notes returned over 5% per year.  

But those historical returns hide the fact that interest rates on bonds today are lower than they’ve been at any point in history and there’s no way we’ll see a return to 5% annual returns until interest rates rise materially (and bonds decline in price, as interest rates go up/down, bond prices go down/up).  You can’t count on bonds, or even a bond-heavy balanced portfolio, to carry you in retirement.

Next, let’s talk about equities.  Stock returns over time have been much higher than bonds of course, as compensation for their higher volatility.  Since 1926, the return on the S&P 500 has been +10.4% per year, double the return on bonds.  And stocks have another attractive feature as well–they tend to do well when bonds don’t (and vice versa).  See the low interest rate period in the chart above during the 1940s (similar interest rates as today)?  Over the 20-year period from 1940-1959, stocks had above-average +14%/yr returns to counteract the low, 2% annual return on bonds.

But the price of stocks in the 1940s, and over much of history, compared to the long-term earnings of the underlying companies (the price-to-long-term earnings ratio), was much lower than it is today.  The chart below plots the historical “Shiller P/E ratio” on the S&P 500 back over 100 years.  You can think of the chart as the opposite of the bond chart above–when the line is closer to the bottom (prices are low relative to long-term earnings), future returns are expected to be higher; when the line is closer to the top (prices are high relative to long-term earnings), future returns are expected to be lower.

You can see stock prices aren’t higher than they’ve ever been relative to long-term earnings, but they’re close.  The year 2000 saw the highest prices ever, and over the next 10 years the S&P 500 actually lost -1.0% per year.

So when we consider the current state of bonds and stocks today–bonds having the lowest yields in history and stock prices at one of their highest levels on record, I’d say this certainly qualifies as one of the, if not the hardest time in history to retire.  The question is: What should you do about it?

The “Time the Market” Option.

Let’s start with what NOT to do.  There is a strong urge on the part of investors and even many financial advisors to try and “time” the stock and bond markets.  The approach goes something like this: I’m going to avoid bonds and hide out in cash until interest rates go back up (and bond returns are better), and I’ll hold very little in stocks right now until the market goes down and prices are more favorable compared to earnings, and then I’ll get back into the market.  

I’ve heard some version of this from countless individual investors over the last 5-7 years.  Most of them are still hiding in cash and they’ve missed out on doubling their portfolio values simply by getting and staying invested.  So don’t do this.  It’s not going to work, you’ll cost yourself a serious amount of wealth, and you’ll be continually stressed worrying about missing out on returns you could have had if you just invested more sensibly.

The “Make Lemonade Out of Lemons” Option.

There’s an alternative, thankfully, to sticking your head in the sand and hoping things magically improve in the future and you don’t suffocate in the meantime.  

First, bonds.  I’ve written extensively about the fact that you don’t need to have a significant portion of your wealth in bonds at any age, even if you’re spending regularly.

Bond returns going forward won’t be very good, but the other aspect of bonds still holds: they’re relatively stable compared to stocks and tend to hold their value when stocks decline.  So you can use bonds as an income reserve that warehouses a few years of your future spending to be tapped during bear markets (losses of -20% or more) in stocks.  How many years? More than two is probably excessive, but if three or four years of your income in bonds helps you to sleep better at night, then the drag of lower returns might be worth it.

What kind of bonds work best in this role? Short-term bonds (average maturities of less than five years) with relatively high credit qualities (AA/AAA + government).  Holding a globally diversified portfolio of bonds helps reduce volatility even further, as different country interest rate movements and therefore bond prices don’t always move in lockstep.

Now stocks.  This is the more important consideration, especially if you’re going to devote the vast majority of your long-term retirement savings to them. For this reason we’ll handle it in steps.

You might think there’s no escaping the relatively high prices and therefore potentially (much) lower future returns from equities, but if so we’ll have to disagree.  Escaping the high prices and low future returns on the S&P 500 (US large cap growth stocks) is precisely what you should do.  And when I say escape I mean diversify.  Into what? Other asset classes with higher expected returns and that do not move in lockstep with the  S&P 500.

Let’s start with US stocks.  The long-term evidence is clear, lower-priced value stocks and smaller cap stocks have had higher long-term returns than the S&P 500 (and large/small growth stocks have had lower returns despite their recent outperformance).  Value and small cap stocks are also trading at MUCH lower price-to-earnings levels today and have the prospect of much higher future returns.  Step #1: diversify your US stock allocation beyond the S&P 500.

Next, international stocks.  The evidence we have (since index data inception in 1975) in non-US developed markets that value and small cap stocks have higher long-term returns matches the US experience.  What’s more, international and small cap value stocks have lower correlations to the S&P 500 than large cap blue chip international stocks (represented by the MSCI EAFE Index & Fama/French International Growth Index) and therefore also provide better diversification.  International stocks also have much lower prices compared to their earnings than US stocks do.  It’s highly likely that international stocks do better than US stocks over the next 10-20 years.  Step #2: Diversify internationally in value and small cap stocks.

Finally, emerging markets.  The data we have isn’t very long (indexes start in 1989), and the data we do have shows that emerging markets stocks are much more volatile than US or international developed markets.  But they can add to a developed country allocation because they often exhibit lower correlation and therefore enhanced diversification.  What’s more, the same value and small cap benefits we’ve seen in the US and non-US developed markets are also present in emerging markets.  Emerging markets stocks today, like international stocks, also trade at much lower relative prices compared to US companies.  Step #3: consider emerging markets and especially value and small cap companies.

Looking at year-over-year returns, we can see the diversification benefits of adding different stock asset classes beyond the S&P 500.  There’s no pattern in returns and quite often the best relative performer for a while becomes the worst, and vice versa.  This is what you’re hoping for as a diversified equity investor–protection against lackluster future returns on the S&P 500.  

Year-to-year results are random, but is there any evidence that these other asset classes can actually produce meaningfully better returns if the S&P 500 does produce disappointing result over a longer period, say 10 years or more?  There is.  The “lost decade” from 2000-2009 is a perfect example of the long-term benefits of equity asset class diversification.  Every single core stock asset class produced meaningfully better returns than the S&P 500 over this period, as you can see in the chart below.  While history never repeats exactly, I would argue the stock market today resembles 2000 more than at any point before.  Ignore the lessons of the “lost decade” at your expense.

Failing To Plan

Ultimately, there is no hiding from the fact that retiring today, or sometime soon, presents very unique financial challenges.  Bond yields are low, stock prices are high, and even these issues don’t consider that we’re all living longer (and therefore will need more income over a longer period) than we were a generation or two ago.

But avoiding the problems will not make them go away.  You have to have a plan to confront these challenges that will allow you to be successful in spite of the difficult investment environment.  I’ve given you the research and information necessary to help you move forward confidently, but unfortunately information is not knowledge and it certainly isn’t customized for your unique situation.  If you’d like to discuss how you can incorporate more of these concepts into your personal retirement plan, please don’t hesitate to reach out for a complimentary second opinion.


Past performance is not a guarantee of future results. Index and mutual fund performance includes reinvestment of dividends and other earnings but does not reflect the deduction of investment advisory fees or other expenses except where noted. This content is provided for informational purposes and should not to be construed as an offer, solicitation, recommendation or endorsement of any particular security, products, or services.