Advisors everywhere know the story all too well: A client worked and saved his entire life and put everything - or nearly everything - into fixed-income securities to prepare for retirement. In doing so, he expected to live out the rest of his life comfortably on returns of 4% to 5%, never touching the principal. Then the world changes: Treasury yields drop to historic lows of less than 2% or even 1%, with some even generating negative returns after factoring in modest inflation, forcing planners and investors to rethink everything.
"What I hear a lot is, 'It's time to refocus on me,' " says Douglas Ciocca, CEO of Kavar Capital Partners in Leawood, Kan. "It was great to have this goal of making all my kids millionaires or funding my charity, but now I need to take care of myself." This may mean spending less in retirement, donating less to charity, gifting less - if anything - to heirs. And it means finding new and reliable streams of income to save, or repair, plans for the future.
To root out the top strategies for fixed income for this month's cover story, Financial Planning spoke with advisors and financial professionals around the country about their varying game plans. Broadly speaking, most include diversification, hedging and retrenching. Many of the solutions go beyond the technical definition of the term "fixed income" to include equities, insurance and trusts that generate income streams.
Above all, creativity is the watchword for forging new fixed-income solutions. "My response to [worried] clients is to embrace this new environment and adapt to it," says Brian Kazanchy, a wealth manager and chairman of the investment committee at RegentAtlantic Capital in Morristown, N.J. "The solutions that were great for the past 10 years ... are probably not the solutions that will serve us best over the next 10 years."
Instead, Kazanchy, Ciocca and other planners are steering away from Treasuries and municipal bonds, moving toward a cornucopia of bonds with higher risks and, they hope, higher rewards. These might include corporate bonds and high-yield bonds, as well as fixed-coupon premium bonds, floating-rate bonds and fixed-to-float bonds.
But, in most cases, planners are letting outside managers do the heavy lifting. Some have made real estate a top priority by investing in the much-maligned world of mortgage-backed securities. Others lobby their clients to diversify out of the markets and buy homes and commercial properties when that makes sense.
For high-net-worth clients who fit the right profile, some planners create income streams through the use of charitable trusts or annuities. Under some circumstances, others are opting to pay high prices for insurance company annuities. In almost every case, planners told FP they were urging clients to put at least some portion of their fixed-income portfolio into equities.
But it's not an easy sell. Kazanchy shares the story of a single client in her late 60s who is eager to retire. Recently, when she went to the bank to renew a CD, she was offered a return of 0.7%, a steep drop from the 4% to 5% the bank was paying a while ago. "Her frustration," Kazanchy explains, "stems from leading a responsible life, working long hours, paying the mortgage on time, forgoing vacations and other purchases in favor of building a nest egg to retire on."
Now, the Federal Reserve's priority is to keep rates low to nurse the housing market and broader economy back to health - at the expense of savers like her. Her two choices, as Kazanchy sees them, are either to pull back on the retirement lifestyle she had worked hard to ensure or to expose some of her portfolio to risk in the hopes of generating growth.
"However, if the risk tolerance is not commensurate with the strategy, [she] will be more likely to do permanent damage to [her] financial well-being by selling out after the market declines," he says. "For investors seeking low volatility and a stable return, the trade-offs can be severe." The following strategies may help mitigate or possibly eliminate the sting of continued market volatility.
There are four bond categories that planners should consider exploring for their retirement-minded clients:
* Mortgage-backed securities. The economic crisis of 2008 exposed a vast global over-evaluation of mortgage-backed securities. Lost in the subsequent stampede to sell were securities that did - and still do - possess strong underlying fundamentals.
"There's a great deal of value there because most investors said, 'I don't want any part of it' " says Hank McLarty, founder of Gratus Capital Management in Atlanta and a former fixed-income trader at Morgan Stanley. "The yields are quite good" - 15% or 16% - "if you have the ability to go find them," he says.