The Fed is likely to keep rates low for a long time, which means investors need to own more equities—if they can handle it, Rick Ferri says.
Rick Ferri, the head of Michigan-based Portfolio Solutions, is all but convinced that the ultra-low-rate environment put in place by the Federal Reserve after the market crashed in 2008 is here to stay for a long time—perhaps as long as 20 years.
That presents definite challenges for investors, particularly older investors who have historically gravitated increasingly to bonds as they head into retirement, Ferri told IndexUniverse.com Managing Editor Olly Ludwig. The problem is that even with a broadly diversified bond portfolio that includes high- yield and TIPS debt, real returns are likely to be zero. The answer? Own more equities and, for retirees, for longer than has been the conventional wisdom. But only if you can “take the heat” of the extra volatility.
IU.com: What can seniors do to maximize returns in the bond market, given the low yields?
Ferri: I look at it by starting out with the total bond market, which is a lotof Treasurys; a lot of agencies; a lot of mortgages and some corporates and Yankee bonds. That’s the Barclays Capital Aggregate bond market, the cornerstone of a fixed-income portfolio. That captures most things, but there’s two asset classes it doesn’t capture: high yield and TIPS. So if you wanted to create a more “total” total bond market, you’d need to add some high yield and some TIPS, about 10 percent of each.
IU.com: When you say 10 percent, you mean 10 percent of your bond-market allocation?
Ferri: That’s correct. But we’re a bit more exotic than that. We use a 60-20-20 combination.
IU.com: We’re talking 60 percent ags; 20 percent TIPS and 20 percent high yield?
Ferri: Yes. All I’m saying is that that’s what we use. If you wanted to match the market, you’d use 80-10-10. And it’s just taxable, including mortgages. Not municipals. The 20-20-60 works well from a modern portfolio theory method, which means you’re going to do rebalancing. When the high-yield market goes down like it did in 2008, we were more buyers of high yield because we need to get it back up to 20 percent of the portfolio. And then over the last few years, high yield has done extremely well, and it’s now more than 20 percent of the portfolio, so we sell some high yield and start buying something else like TIPS or aggregate bonds. But the rebalancing helps mitigate the risk.
With 20 percent of the portfolio in high yield, it makes up for the fact that I’m getting nothing on the TIPS side, and the net result in my clients’ portfolios is that I end up getting a 2 percent cash flow yield out of the portfolio.
IU.com: So what percent of equities should a senior remain invested in?
Ferri: The bottom line is, How much money do you have? If you have $10 million and you’re spending $100,000 a year, heck, you may as well be 100 percent in equity. Because you’re never going to run out of money. The dividend yield on stock is 2 percent or higher if you have a diversified portfolio, so you’re going to be making $200,000 a year on dividend income. So if you’re only spending $100,000 a year, you may as well be 100 percent in equities.
If you were solely in bonds, like Bill Bernstein was telling you, they’re a zero-percent-returning asset class over the next 10 years, so you’re going to get nothing on a real-return basis. So, every dollar you spend is actually principal that you’re taking out of your portfolio. So the idea of moving to fixed income as you get to retirement is going to be based more on how much money you have and what kind of a financial position you’re in rather than whether you can handle the risk.