The Retirement Income Problem

The most vital and pervasive issue investors will face in the next decade is how to wring out enough income from the savings they have amassed to maintain or enhance their lifestyle. To do so, they will need to be far more flexible in their investment approach. They also must adapt to an environment for “high quality bonds” (Treasuries, Municipals and Corporates) that does not at all resemble that which they are accustomed to. In summary, they must throw out many of the old rules they knew regarding bond investing. Failing to do so could be the difference between meeting their objectives, and experiencing the kind of financial and emotional pain that followed the dot-com bust and real estate crash. Yes, retirement income strategy is THAT important today. The easy solutions are gone.


Investors’ concerns are rooted in the ability to maintain or improve their current lifestyle. Any hurdle in doing so can cause stress, and leads to emotional decisions. For bond investors, this has been a fairly smooth ride for 30 years, as interest rates have been falling and thus, prices of high-quality bonds (Treasuries, Municipals, and higher-rated Corporate bonds) have been rising. This was the case until a few years ago, when it appeared that finally the issue of mounting U.S. debt would cause the decline in rates to slow. Since way back in the Reagan Administration, we have seen only temporary breaks in this falling interest rate trend, such as in 1994 when the Fed raised interest rates seven times. If you were a bond investor in the past three decades, life was sweet. Whether you owned bonds individually or through mutual funds, you looked like a genius. In fact, it was the greatest bond bull market in modern history (not genius) that have made bond managers appear to be superheroes.

High-quality bond prices do not behave like stock prices. Stock prices are determined by everything from how profitable a company is, to what news events the company releases, to the desire of buyer and sellers to act (regardless of what the actual news is on the company). High-quality bonds are different because their prices are determined largely by interest movements. But while a stock can go up or down regardless of the actual news (due to buying and selling forces of the market), bonds are more about mathematics. If interest rates go way down, bond prices are going to go up. Not maybe. Not probably. They WILL go up!

And, when the party stops, it will hit many investors with a shock that will rival what we experienced when the tech stock bubble popped. In fact it could be worse. Why? Because most investors are realistic when it comes to stock investing. They know from experience than stock prices rise and fall regularly. In contrast, imagine the shock of seeing your high-quality bonds drop in value. How do you feel when your allegedly-safe part of your portfolio is plunging? We think it will be a very emotional issue for investors of all shapes and sizes. This is not meant to be a sensationalistic commentary and do not mistake the strong words here for scare tactics. It is my attempt to explain what will be a very complicated issue for many investors. And it needs to be addressed with them NOW.

Based on the outrageous amount of cash inflows to bond mutual funds over the past several years, I don’t think the message is out there, at least not yet. And, like many bits of conventional wisdom, the message will spread very slowly. The unfortunate fact is that if you look at how U.S. Treasury

bonds of intermediate-term and long-term maturities performed from the end of 1976 through the end of 1981, it reminds us that bonds can also be dangerous at times. During that 5-year period, long-term Treasuries lost over 40 percent, and intermediate-term Treasuries lost over 15 percent. Now, I am talking solely about the price component of the bonds, not the income. Back then, high bond interest rates served as a decent buffer to the falling bond prices. However, if bonds were to lose price value along those same lines today, the cushion from the low-interest-rate environment of the twenty-first century is razor-thin.

Complicating matters for investors is that despite a series of seemingly awful economic headlines (U.S. debt, unemployment, rising food and gas prices, Eurozone strife, China’s economic slowing and the ever-present threat of terrorism…the stock market has gone up. The Dow hit a new nominal high, and S&P 500 index is within striking distance of the level it reached in 2000 and again in 2008. While we are not about to make short-term predictions about stock prices, it is clear that a cooling off period in stock prices would not be a big surprise.

At a recent industry conference our team attended, the question was asked repeatedly by members of our industry : how do investors and their financial advisors cope with the predicament of low bond yields and the threat of stock market volatility? Specifically, how do we navigate through the coming years when traditional solutions fall short? While we have determined and identified the risks, and that puts us at the head of the class in that regard, it still does not give us a path to success. And if you are like many investors from the “Baby Boom” and “Silent” generations, you are asking for answers where no obvious ones exist.

And while Ben Bernanke and his Federal Reserve have delayed the pain by buying up a massive amount of Treasury bonds issued by the U.S. government (the so-called QE and Twist strategies), it seems to us just a matter of time until the old Laurel and Hardy line is directed at central bankers around the world: “well, here’s another mess you’ve gotten me into!”

And unlike the last couple of “investor crises” the next big investor headache may not be triggered by a stock market decline. Instead, it could be a modest increase in bond yields, primarily U.S. Treasuries, the benchmark around which most bond asset classes are priced. For years, pundits have warned that government policies which ballooned our national debt would stock inflation ala the late 1970s. That is supposedly the prevailing worry for bond investors, since a ratcheting of rates higher by the Fed and other central banks from historically low levels could prompt fear and panic in the bond market, as bond prices plunge. We are not trying to predict if or when that will happen. We prefer not to predict financial catastrophes, since that sort of guessing-game is not the most productive time we can spend. Instead, we prefer to size up the possibilities and act with conviction when that is required.

So, consider this: the 10-year US Treasury Bond touched 2.40% last March and was over 3.00% in July of 2011. Simply returning to those levels from current levels during 2013 would lead to some upset bond investors. This is not like the 1970s where you had a 15% coupon rate to cushion the drop in bond prices. As stated earlier, the cushion is razor-thin because that’s what high-quality bonds are now. So simply reverting to recent levels following such a dramatic overshoot in yields to the downside since the 2008 banking crisis could create a tough atmosphere for bond investors. This is particularly difficult for the Billions of dollars of investment assets that have piled into bond funds the last few years.

Income-oriented investors, many with their advisors’ encouragement, have reached for yield into areas they don’t understand, and avoided equity investing. Don’t believe me? Here is a quote from the FINRA website:

Don't reach for yield. The single biggest mistake bond investors make is reaching for yield after interest rates have declined. Don't be tempted by higher yields offered by bonds with lower credit qualities, or be focused only on gains that resulted during the prior period.

We think investors have piled into more speculative bonds and their associated high yields because of a misunderstanding. They think equities are too volatile for them, and that the stock market has been a losing long-term proposition for a long time. In response, they take risks in areas that they are not comfortable with, but deem necessary to meet their goals. They are limiting their thinking to traditional uses of equities (primarily equity mutual funds) in a so-called “diversified” investment portfolio alongside bonds. This is NOT the only context within which to use stocks.


As fiduciaries, it is our job to put the client’s best interests FIRST. A central part of that is not settling for mass-produced solutions, and engineering our own when needed. A decade ago I created something called the “Hybrid strategy” which aimed to guard stock portfolios against major losses. It allowed us to survive a very ugly environment last decade. But today we are faced with a very different, very real problem as noted above. When I started Sungarden in January of 2012, I focused like a laser on this issue and am carefully building a like-minded team around me to help our clients not only survive, but thrive in this new environment.

We think the traditional stock-bond “balanced” approach is dead. We also feel strongly that investors can use equity investing to get what they used to get from bonds…without using traditional bonds at all. Unfortunately, many financial advisors have simply given in to their clients and threw them into something that sounded good, and pacified the client – they piled into asset allocation funds, alternative investment products, high yield funds, closed-end funds, etc. These approaches all have benefits to certain investors, but it’s the skewing of the use of these approaches that has us so concerned. That is why we have been and will be vocal about this issue within our peer network and within our industry. As with the dot-com bubble, the real estate bubble or any other financial hurricane, the best way to deal with the bubble in high-quality bond prices is to deal with it now, not after the storm arrives.

As investment advisors, we have a choice to confront our clients’ stresses in a proactive fashion, or simply deliver the “same old” solutions that our peers do.The comfort of “safety in numbers” vanishes quickly when markets get unruly. At that point, it is usually too late for the advisor to sidestep a lot of the financial and emotional damage suffered by their clients. It doesn’t have to be that way.


To create a serious solution to the retirement income conundrum, we must first define what “success” in such a strategy will look like. To us, there are five things a retirement income portfolio must aim to deliver:

  1. Preserve Capital by actively defending against big losses
  2. Produce Income that is sufficient, stable and growing
  3. Grow the portfolio over the Long-Term
  4. Reasonable total cost (this may not be the cheapest alternative available, but the one that has the best tradeoff with the potential merits of the investment)
  5. Liquidity that is intraday or daily

Or, to put it another way, we try to produce income and growth, and sidestep the stock market declines and bond bubble that are likely an overhang for all investors for the foreseeable future. Here is how we approach this head-on at Sungarden:

  1. Preserve - we prioritize hedging against major losses. We use inverse ETFs (Exchange-Traded Funds) but can employ protective options as well, if needed. ETFs are a cross between index mutual funds and stocks. They trade on the public stock exchanges, and they represent a set of securities having a common theme. These securities are a key part of our attempt to deliver on our primary goal as investors: “avoid the big loss.” Since different investors have varying definitions of what a “big loss” is, we offer different strategies at our firm (more detail on that in our next newsletter issue).
  2. Produce Income – dividends that are sufficient for client needs, stable and growing offer a great alternative to bond interest from a washed out bond market. After all, while governments and consumers are still limping from the five year old banking crisis, many corporations managed well and thus have a lot of cash. Maintaining their dividend payouts is one use of that cash. Another could be raising the dividend. We devote significant attention in our research to separating companies whose dividends we believe are sustainable from those whose yields are temptingly high, but not likely to continue without being cut. We find that in a more relaxed stock market environment, investors can get away with “chasing yield” but when financial conditions start to decline, it is another story. As Warren Buffett famously said, “when the tide goes out, you can see who was swimming naked.”
  3. Long-Term Growth – we have identified 10 long-term themes we consider to be undeniable, and they form the focus of our investment approach. We can discuss these with you in more depth off-line. By staying focused within these themes, we aim to capitalize on specific secular trends that will outlast the occasional bumps and bruises that limit returns of stock investors that simply “buy the market.” And while we hope to own these companies for a long time, we do not hesitate to practice “portfolio management” to cut losses or sell a stock we have not owned for very long, if our analysis suggests that is a good idea. As with everything we do at Sungarden, it’s a constant tradeoff between our expected reward potential and potential decline in value. That balancing act is what we work at every day. And after 27 years in this industry, I can truly say I STILL learn something new every day!
  4. Total Cost – our industry is obsessed with finding low-cost mutual funds and ETFs. But think about it: what is the expense ratio of an individual stock? ZERO. By converting our portfolios from their former mutual fund orientation to one that mixes individual stocks and ETFs (we use only ETFs and funds for smaller accounts), we estimate that the “expense ratio” (i.e. internal cost of the securities we own) of our portfolios is less than 1/3 of what is had been two years ago. We also believe that we can derive more quality income from individual stocks than buying stock mutual funds, as fund expenses cut into the dividends produced.
  5. Liquidity – stocks trade intraday, ETFs do as well. Mutual funds offer next-day liquidity. That’s as far as most investment approaches need to go, in our opinion.

In early 2012, to respond to investors’ desire for a consistent income stream amid the headwinds of historically low interest rates, we developed our Cash Flow Focused (CFF) strategy. CFF seeks to retain much of volatility management characteristics of ELSI and produce income at a target rate of 3% above the dividend yield of the S&P 500 (the S&P yields about 2% as of this writing, so CFF targets a 5% yield.

CFF is our solution to the traditional income-generating portfolio. We have offered it to clients for just over a year. Due in large part to the increased desire of our clients to have an alternative to traditional income strategies and our ability to create a compelling one, we now manage a significant portion of our clients’ total assets in the CFF strategy.


Historically, bonds have been the "safe" portion of one's portfolio. However, investors are increasingly concerned about the current interest rate environment and the threat of rising rates.

In our opinion, portfolios of high quality bonds (treasuries, corporate, municipal bonds) are at risk. Just as important, investors are not generating sufficient yield today without taking such risk. The traditional answer for "safe" investing is no longer safe. It requires a different approach, one that the advisor can deliver and the client can understand and appreciate. As always, we welcome your questions and feedback.

Rob Isbitts ([email protected]), a 26-year industry veteran, is the founder and chief investment strategist of Sungarden Investment Research ( Sungarden provides advisors with an investment process, portfolio design and model portfolios. Rob has written two investment books, created several portfolio strategies, and is a former chief investment officer and mutual fund manager. He offers advisory services through Dynamic Wealth Advisors, a registered investment advisor.

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