Idea Transcript
Investment & Portfolio Strategy Five Threats to Your Retirement September 2013
Thinking about retirement is no longer a future event for many Americans; most recognize the need for careful planning throughout their working years. While it is a positive that Americans are expected to live longer, this can add to the already daunting challenges of funding a comfortable retirement. With the help of a PNC Wealth Management advisor, investors can map out a course for meeting their financial goals. This process often entails an investment objective of saving and of investing a portfolio designed to help meet individual cash flow needs in retirement while preserving capital and managing risk. We have written several times about different (yet not mutually exclusive) methods of investing for retirement (see PNC Wealth Management’s May 2013 white papers, Retirement: Total Return and Retirement: Income Floor), which provide insights on how investors may seek to achieve their stated objectives. With the goal of investing for retirement in mind, we want to address five threats to retirement of which an investor should be cognizant. n n n n n
inappropriate asset allocation; higher interest rates; loss of purchasing power (financial repression); rising health-care costs (private and public); and changes in net worth.
What follows is a discussion of these risks and how we believe investors can seek to mitigate them.
Inappropriate Asset Allocation
E. William Stone, CFA®, CMT Managing Director, Investment & Portfolio Strategy Chief Investment Strategist Marsella Martino Senior Investment Strategist Michael Zoller Investment Strategist
pnc.com PNWI0090113
Selecting an appropriate long-term strategic asset allocation that matches an investor’s goals, risk tolerance, and investment holding period is vital to managing funds set aside for retirement. In practice, this process takes a significant amount of time for clients and financial advisors to develop an understanding and to plan. This is time well spent—being too conservative or too aggressive could likely prevent an investor from meeting goals within the appropriate time period. It was not that long ago that a fairly low-risk portfolio could have an expected real return high enough to support a relatively safe 3-4%-per-year drawdown. However, the recent extended low-interest-rate environment, aided by Federal Reserve (Fed) policy actions, has made it much more difficult for investors to
Five Threats to Your Retirement
even keep pace with inflation while maintaining a low-risk profile. Thus, positioning a portfolio too conservatively can pose a threat to the investor’s goals, since the goal for essentially all retirees is to maintain—or better yet grow—purchasing power, and a tooconservative position can erode purchasing power. Who does not want to keep or even improve their standard of living in retirement?
Chart 1 Net Mutual Fund Flows by Type 2008 2 008 1,200 1 ,200
2009 2 009
2010 2 010
2011 2 011
2012 2012
Y YTD TD 2 2013 013
T Total: otal: 2 2008-6/13 008-6/13
1,000 1,000 Billions Billions of of Dollars Dollars
800 800
One lesson learned from the financial crisis and subsequent Great Recession is the importance of a well-balanced portfolio that includes a diversified mix of asset classes. During this period, investors flocked to fixed-income, driven by a variety of reasons, including preservation of capital and assuring future cash needs could be met. Looking at the flow of assets into different asset classes, the so-called “flight to safety” is clear (Chart 1).
$1,106
600 600 400 4 00
$93
200 2 00 0 --200 200
-$576
--400 400 --600 600
-$496
Emerging Domestic Equity Equity Total Total Equity Equity Emerging Domestic Markets Equity Equity Markets
Fixed Income Income Fixed
Source: Strategas, PNC Wealth Management However, it is also important to recognize the consequences of being too conservative in retirement planning. Using an extended time series of historical returns for the PNC Wealth Management asset allocation profile (Chart 2), it has been demonstrated that over any rolling 10-year period, taking less market risk has kept real returns tempered, and we believe it could even result in drawing down more principal than originally anticipated during retirement. This is highlighted further by looking at the 10-year Treasury yield compared with the U.S. Consumer Price Index (Chart 3, page 3). With a 10-year Treasury yield around 2.8% it's unlikely a Treasury portfolio will yield a positive real return in the current environment with long-term inflation in the United States averaging a little less than 3%. Thus, the cost of safety is extraordinarily high.
Chart 2 Historical Returns and Range of Returns by Asset Allocation Profile (Percentage Annual Returns, 1926-2012) 20.1%
Aggressive -1.4%
-43.3%
17.2%
Growth
44.5%
9.3%
0.4%
-35.6%
54.0%
9.8%
16.3% Balanced 1.6%
-29.6%
15.7% Moderate Highest 10-Yr. Rolling
2.8%
-23.4% Conservative
Geometric Mean
8.1% 15.0%
Highest 1-Yr. -17.1%
3.8%
7.4%
Lowest 10-Yr. Rolling 1.9%
-6.9% -60% -60%
-40% -40%
-20% -20%
Source: Ibbotson Associates, PNC Wealth Management
2
11.3%
Preservation
Lowest 1-Yr.
0% 0%
37.0%
8.7%
5.3%
29.2%
26.7%
17.7%
20% 20%
40% 40%
60% 60%
Five Threats to Your Retirement
Chart 3 10-Year Treasury Yield versus Inflation 14 14 12 12 10 10
10-Year Less Year-over-Year Change in CPI 10-Year Less Long-Run Average CPI
Percent Percent
8 6 4
Forecasting returns for different asset allocations over an investor’s investment holding period likely provides a picture that helps frame expectations and thus allows for decision making. Being too conservative with an asset allocation exposes the investor to the risk of a negative real return over the medium to long term (the cost of being too conservative). Conversely, there also is a risk of being too aggressive, putting at risk capital that may need to be drawn upon in the nearer term.
2 0 -2 -2 -4 -4 -6 -6 1953 1953
1961 1961
1969 1969
1977 1977
1985 1 985
1993 1 993
2001 2 001
2009 2 009
Since accurately determining the short-term movement of stocks is unlikely, we argue that investors should focus on what is knowable and controllable. When determining their asset allocation, investors should focus on their: n
Source: Bureau of Labor Statistics, Bloomberg L.P., PNC Wealth Management
n n n n n
goals; risk tolerance; expected liabilities; expected cash inflows; investment holding period; and personal situation.
Each of PNC Wealth Management’s six asset allocation profiles (Table 1) differs from the next in the stock/bond/cash weighting by about 15-20%. These increments are just enough to result in materially different risk and return characteristics for each asset allocation profile. They are designed to minimize gaps or redundancies in the risk/return spectrum. The impact of these increments is for a variance of a little more than 0.5% in historical return. The risk spectrum has larger gaps in terms of worst one-year returns due to the large variability of one-year stock returns, but the worst 10-year numbers are much more controlled. Historically, even the most conservative of the asset allocations has outpaced inflation, on average (Chart 2, page 2).
Table 1 PNC Wealth Management Asset Allocation Profiles Stocks Bonds Cash Total
Preservation
Conservative
Moderate
Balanced
Growth
Aggressive
15.0% 30.0 55.0 100.0%
35.0% 65.0 0.0 100.0%
50.0% 50.0 0.0 100.0%
65.0% 35.0 0.0 100.0%
80.0% 20.0 0.0 100.0%
100.0% 0.0 0.0 100.0%
Source: PNC Wealth Management
Importantly, with the high share of cash in the preservation portfolio and limited market risk, it is unlikely that this strategy will have a positive real return over the medium term, given the low nominal yields on safer assets. According to our calculations, over the 12 months ended June 30, 2013, cash returned a hair over 0%; bonds (Barclays U.S. Aggregate Index) had a capital loss of 0.69% due to rising yields; while stocks (S&P 500®) returned a sharply higher 20.6%. All told, a portfolio of 55% cash, 30% Barclays U.S. Aggregate, and 15% S&P 500 would have returned about 2.7% over the 12 months. Although outpacing inflation over that 12-month period, it is not too difficult to imagine a scenario in which the capital appreciation of stocks fails to make up
3
Five Threats to Your Retirement
Table 2 Long-Term Government Bond* Total Returns Decade 1930s 1940s 1950s 1960s 1970s 1980s 1990s 2000s 2010 to 7/31/12
Capital Appreciation 1.9% 0.9 -3.0 -3.0 -2.0 1.5 1.5 2.5 4.9
Income Return 3.0% 2.3 3.0 4.6 7.7 10.9 7.2 5.1 3.3
Total Return 4.9% 3.2 -0.1 1.4 5.5 12.6 8.8 7.7 8.3
*Ibbotson Associates Long-Term Government Bond Index Source: Ibbotson Associates, PNC Wealth Management
for the poor price appreciation of bonds and the scant yields of cash. This expectation for more restrained returns from bonds is in the context of history; capital appreciation of long-term government bonds has rarely if ever been this strong (Table 2).
Higher Interest Rates
The long-term view of interest rates is an important part of the retirement investing equation. Facing the eventual rise in long-term interest rates, investors should evaluate their portfolios for this and other factors.
B Barclays arclays IIndexes ndexes
Following the financial crisis and subsequent Great Recession, the United States has been in an extended period of low short-term interest rates. The Fed-led recovery has been an important variable in recent years, contributing to the investment landscape. Assistance by the Fed in terms of Chart 4 monetary policy was always intended as temporary; however, Correlations of Barclays Aggregates to S&P 500 and as the economy continues to slowly strengthen, realistic expectations continue to mount that the low-interest-rate party Commodity Index Index 0.07 could be drawing to an end. The Fed is not planning for rates to S&P 500 0.04 rise meaningfully anytime soon. Nonetheless, the rise in interest U.S. Credit Credit 0.88 rates continues to be an eventuality, even though we do not U.S. Treasury: Treasury: 0.79 U.S. TIPS expect a steep rise in the near term. U.S. Corporate Corporate High Yield EM USD Aggregate Aggregate
0.26 0.61 0.88
U.S. Treasury Treasury 1-17 Year Year Municipal Bond
0.70 1.00
U.S. Aggregate Aggregate
0.00 0.00
0 0.20 .20
0 0.40 .40
0.60 0 .60
0.80 0 .80
1.00 1 .00
C Correlation orrelation It is important to look at all asset classes’ potential reaction during times of higher rates. In particular, we take a moment to Source: J.P. Morgan, Barclays Capital, Bloomberg L.P., PNC Wealth Management discuss fixed income. Flow-of-funds data suggest that investors have swarmed to fixed income in recent years in response to the financial uncertainty stemming from the financial crisis. This demonstrates the importance of assessing asset risk as bond portfolios have grown. We believe fixed-income investors can, with prudence, better manage risks through a longterm approach to investing and strategic diversification (Chart 4). Again we remind investors of the importance of fixed income to portfolios for preservation of capital, for income, and for low correlations of returns to stock returns, to name just a few considerations.
4
1.20 1 .20
Five Threats to Your Retirement Financial repression occurs when a government implements policies that funnel money to itself that would have otherwise flowed elsewhere. As a result of these policies, nominal interest rates are lower than they would be in a more competitive market. These low nominal rates combined with inflation—even if inflation is around the current Fed target of 2%—is enough to erode the real value of investments. There are several ways governments are able to keep rates low. The two most relevant in the United States are: n n
de-facto caps on interest rates; and the creation of a captive domestic audience.
The Fed’s purchases of mortgage-backed securities, agency debt, and long-term Treasuries have been an effective tool for keeping borrowing cost low in many markets. On the shorter end of the yield curve, the Fed is keeping its policy rates (federal funds rate, discount rate, and interest paid on excess reserves) low. The best example of creating a captive domestic audience is the regulatory standards created by the Basel Committee on Banking Supervision, which give a lower risk score for government debt than most other securities. It is important to point out here that we are not judging the appropriateness of these policies and regulations. Regardless of our opinion, the fact remains that rates on Treasuries and other high-quality (low-risk) fixed-income securities are likely to remain low. At the same time, there is little reason to expect that inflation will deviate too far from the Fed’s soft target of 2%. Under these circumstances, real interest rates will likely be extremely low or negative, which is a key feature of financial repression. Over the past several decades, the United States has seen the effects of financial repression and negative real interest rates. According to research done by Reinhart and Sbrancia, between 1945 and 1980, real interest rates have been negative 25% of the time in the United States. 1 This created interest-cost savings of 3-4% per year, which helped the U.S. government reduce its debt load. This reduced debt burden came at a direct cost to savers in the United States because the purchasing power of their investments was reduced. Earning real positive returns on fixedincome investments in this environment was challenging.
Loss of Purchasing Power Despite inflation remaining below the long-run average, investors preparing for retirement should be aware of the threat of declining purchasing power. This has particular importance for investors thinking about retirement because inflation chips away at purchasing power over time—the reduction in purchasing power is often difficult to see when it is happening, but it is very real. Short-term interest rates are likely to remain low into 2015, creating a difficult environment for earning a positive real (inflation-adjusted) return from short-term bonds and cash at tolerable levels of risk. In the past we have often discussed investing in a low-interest-rate environment, and this theme will continue to be important through the near term. We will frame this discussion as investing during a time of financial repression. For some investors, the relative safety of investing in Treasuries or other highquality fixed-income securities may still make sense. If unable or unwilling to tolerate the higher volatility associated with equity investing, they may still find it appropriate to have a large share of a portfolio in Table 3 high-quality bonds or cash. Historical Average Annualized Returns However, it is important to be January 1926-July 2013 Real Nominal aware that after adjusting for S&P 500 6.82% 10.00% inflation, the return on such Long-Term Gov’t Bond 2.49 5.54 investments is likely negative; 30-Day T-Bill 0.52 3.51 thus, a dollar invested today Inflation NA 2.97 will purchase less in the future. Source: Ibbotson Associates, MorningStar, Taking a long-term view of PNC Wealth Management annualized returns, we show the effects of inflation on returns on several asset classes in Table 3. Furthermore, considering several times in history, including during the early 1940s when the government implemented fixed interest rates on Treasury securities, we believe that investors seeking positive real returns should avoid Treasuries when nominal rates are below average long-term inflation. If you assume inflation is about average through the near term, the inflation-adjusted return on a 10-year Treasury is currently negative. In fact, taking the roughly 3% annual inflation rate as a constant, we see that real rates have never been lower than they are now. The analysis changes when the actual year-over-year CPI is used, but it is difficult to imagine anyone accurately predicting inflation during the volatile 1970s and early 1980s (Chart 2, page 2). It is important not to lose sight of where the bond market is in the context of history. Looking at the history of the 10-year Treasury note yield gives an idea of what a bull market in bonds it has been over the past three decades (Chart 5, page 6). Given the steady march downward, there does not appear to be room for yields to move much lower.
1
Carmen M. Reinhart and M. Belen Sbrancia, “The Liquidation of Government Debt,” National Bureau of Economic Research Working Paper Series, Working Paper 16893 (March 2011).
5
Five Threats to Your Retirement
To analyze returns during a bear bond market you need to go back decades. Looking back at other bear bond markets, it can be seen that purchasing or holding long-term government bonds at very low yields bodes ill for portfolio returns. For example, if a 2.5% constant maturing 30-year bond was available in 1946, it would have fallen from $101 to $17 by 1981 or a decline of 83%. This was a significantly worse performance than the 2 average return on U.S. equities over that time period.
Chart 5 10-Year Yield versus Nominal GDP (3/31/62-6/30/13) 16 16 14 14 12 12 10 10 8 6
As the economy continues to strengthen, interest rates are likely to move higher as rates normalize. History shows that the 10-year Treasury yield should typically be around the nominal rate of U.S. GDP growth (Chart 5). With PNC Wealth Management’s nominal GDP growth estimates of approximately 3% in 2013 and 4% in 2014, the pressure is likely higher on interest rates. This could pose a problem for bondholders, particularly investors with outsized bond positions and long maturities.
4 2 0 -2 -2 -4 -4
Nominal GDP (percentage change year earlier) 10-Year Treasury Yield (percent)
1962 1962 1967 1967 1972 1972 1977 1977 1982 1982 1987 1987 1992 1992 1997 1997 2002 2002 2007 2007 2012 2012
Source: Bureau of Economic Analysis, Bloomberg L.P., PNC Wealth Management
Currently, with few inflationary pressures in the economy, the Fed has maintained its policy on short-term rates, stating that the federal funds target rate will remain close to zero at least until either the unemployment rate falls below 6.5% or inflation one to two years out appears set to move above 2.5%. Given that there is no sign that the inflation threshold will be hit anytime soon, the unemployment rate is more relevant. Even there, we do not believe the unemployment rate is likely to move below 6.5% until early in 2015, so we expect that short-term rates will remain close to zero for another couple of years. To be clear, one should not extrapolate this into the view that investors should own no bonds. A core belief of the PNC Wealth Management Integrated Investment Approach has always been to own securities for a specific purpose. Bonds continue to fulfill such a purpose—consistent income generation—which is difficult to obtain elsewhere. One could also view high-quality bonds as a form of insurance, in that risky assets such as stocks are likely to do better over the long term but are much more susceptible to large losses. As opposed to a wholesale elimination of bonds from a portfolio, what are the implications if interest rates remain low? In our view, investors should focus on their income needs and tolerance for price volatility when setting their bond allocations, but it would be wise not to count on any price appreciation in bonds when projecting future returns. Within bonds, an allocation to non-Treasury fixed income, such as municipal bonds, corporate bonds, or absolute-return-oriented fixed-income strategies, could be appropriate. A benefit of such an allocation is that it provides extra yield over and above Treasury bonds. Also we have long discussed the merits of adding alternative assets to portfolios, including Treasury Inflation-Protected Securities, as a method to retain purchasing power. For more information 2
Sidney Homer and Richard Sylla, A History of Interest Rates, Third Edition, Revised (Hoboken, NJ: John Wiley & Sons, Inc., 1996).
6
Five Threats to Your Retirement
regarding TIPS please see our white paper Neither Fish nor Fowl: A TIPS Primer. All told, we believe investors will likely continue to face low rates over the near term. This has many benefits to an economy that is in the midst of a tenuous recovery. However, this environment is not without costs to investors, who must be cognizant of the potential erosion of purchasing power when building a retirement portfolio. In 2010, PNC Wealth Management began advising clients to consider a tactical allocation to leveraged loans within the recommended profiles in order to provide some defense against a possible rising-interest-rate environment. In addition, we added an allocation to global bonds to further diversify away from low developed-country yields. Recently, PNC Wealth Management added an absolute-return-oriented fixed-income strategy tactical allocation (see July 2013 Investment Outlook, Breaking the Bonds).
Rising Health-Care Costs The consequences of a reduction in purchasing power are magnified when applied specifically to health-care spending. Although it is not the most pleasant of topics to think about during the planning-for-retirement phase of life, it must be considered that health care will make up a larger share of consumption than in the younger years—currently health care is 15% of the average annual spending per person (Chart 6). This spending is just an average and, as one would expect, health-care spending rises with age, according to a report by the Bureau of Labor Statistics.
Chart 6 Health-Care Expenditures Share of Personal Consumption
Chart 7 Consumer Prices: Headline and Medical Care (1/30/48-7/31/13)
(3/31/59-6/30/13)
16
Year-over-Year Percentage Change
18 16
Percent
14 12 10 8 6
12 10 8 6 4 2 0 -2 -4
4 1959
14
1969
1979
1989
2009
1999
Source: Bureau of Economic Analysis, Bloomberg L.P., PNC Wealth Management
1948 1954 1960 1966 1972 1978 1984 1990 1996 2002 2008
Source: Bureau of Labor Statistics, PNC Wealth Management
The price of health care has been increasing rapidly over the past 70 years, which has likely already caught some retirees by surprise and is a reason government spending on health care (Medicaid and Medicare) has soared. The headline CPI has averaged a 3.7% year-over-year increase since 1948, while the medical care component of CPI has averaged a 5.5% year-over-year increase (Chart 7).
7
Five Threats to Your Retirement
At the current projected rate of growth, these entitlement programs will take up the entire tax revenue by 2050 if the ratio of tax receipts relative to GDP stays near the long-term average (Chart 8). These forecasts suggest that reforming entitlement outlays will need to be a key part of any meaningful fiscal reform.
Chart 8 Major Entitlement Outlays and Tax Revenues 2 5 25 Tax Revenue
Historical Tax Level=18.4%
2 0 20 P Percentage ercentage o off G GDP DP
The fast-paced rise in health-care costs is problematic, leaving retirees on an uncertain path with government spending on health care unsustainable. To further this point, we look at the Congressional Budget Office’s estimate of growth in key entitlement programs as a percentage of GDP over the next 39 years.
1 5 15 M edicar e Medicare 1 0 10 M edicaid Medicaid 5
S ocial S ecurity Social Security
0 2 000 2 005 2 010 2 015 2 020 2 025 2 03 0 2 035 2 040 2 045 2 050 2000 2005 2010 2015 2020 2025 2030 2035 2040 2045 2050
These potential headwinds from health-care costs could result in more (inflation-adjusted) dollars being allocated to medical care. This type of scenario is difficult to prepare for, but should be considered when developing a plan for retirement.
Changes in Net Worth The threat of a sharp decline in net worth feels ever more pertinent in the context of the Great Recession (Chart 9). Once a person is nearing or has entered retirement, the ability to recover from a negative wealth shock (a decline in house or equity prices) is greatly diminished. For the most part, there is no additional paycheck that can be invested to make up for the loss of principal. It is also more likely that risk appetite is too low to accept enough market risk to recover from the shock. This is largely a timing problem. And as the financial crisis illuminated, a sharp drop in asset prices at the wrong time can be particularly troublesome to those approaching retirement age.
Source: Congressional Budget Office, PNC Wealth Management
Chart 9 Changes in Net Worth 30 20
Percentage P ercentage Change
Coming up with a plan to address long-term fiscal issues is a daunting task. Although much uncertainty remains, it is not too hard to imagine a scenario in which government spending on health care declines (Medicare), while the cost of health care continues to rise faster than headline inflation.
10 0 -10 -20 -30 -40 -50
8
2004-07 2004-07
2007-10 2007-10
Source: Federal Reserve, PNC Wealth Management
Home Values The decline in home prices has weighed heavily on net worth, and remains a formidable threat for retirement. According to recent Fed data, a primary residence makes up almost 30% of family assets, the largest single asset Jesse Bricker, Arthur B. Kennickell, Kevin B. Moore, and John Sabelhaus, “Changes in U.S. Family Finances from 2007 to 2010: Evidence from the Survey of Consumer Finances,” Federal Reserve Bulletin 98 (June 2012): 1.
Changes are based on inflation-adjusted dollars. 2 2001-04 001-04
We believe a sharp decline in home prices is the bigger of the threats, given the historical recovery period. This point is furthered by the June 2012 Federal Reserve Bulletin, “…Although declines in the values of financial assets or business were important factors for some families, the decreases in median net worth appear to have been driven most strongly by a broad collapse in 3 house prices.”
3
Median Mean
Five Threats to Your Retirement
(Chart 10). Such a high concentration of a largely illiquid asset can quickly change the path of a retirement plan.
Chart 10 U.S. Households’ Real Estate Assets as a Percentage of Total Assets
There are a couple of reasons this could be a threat.
(3/31/59-3/29/13)
n
34 32
Percent
30 28
n
26 24 22 1959
1969
1979
1989
1999
For people attempting to retire and move to a more retirement-friendly state—for weather or cost of living reasons—the decline in home prices and the extended lack of liquidity in many real estate markets are acting as constraints, impeding the planned retirement move. Many soon-to-be retirees are now coping with the fact that their largest asset is worth a lot less than previously anticipated. This is potentially causing a postponement of retirement or forcing changes to goals.
2009
Source: Federal Reserve, Bloomberg L.P., PNC Wealth Management
Chart 11 Housing Prices (3/31/00-6/30/13) 420
1,700
400
1,600
The housing market is now recovering, which is having an important effect on consumer confidence and economic outlook. Because real estate tends to be a consumer’s biggest asset, rising home prices have a marked impact on consumer balance sheets. Home prices, while still off a low base, appear finally to be adding much needed value back to homeowners’ balance sheets (Chart 11). While the big picture certainly looks much improved from the deep recessionary days, real estate tends to be local, and home values have improved in some areas more than others, affecting investors differently, sometimes dramatically so.
1,500
380
1,400
360
1,300
340
1,200
320
1,100
300
1,000
280
900
260
800
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Given our current expectations for a modest housing recovery, it will take until around 2020 for house prices to reach their pre-housing-bubble peak. This means the decline in wealth is essentially permanent for many people nearing retirement. For individuals still far away from retirement, we believe these concerns should be remembered and factored into retirement planning.
Source: Federal Housing Finance Agency, Bloomberg L.P., PNC Wealth Management
One way we recommend protecting your retirement from an unexpected decline in wealth is by setting proper expectations. Scenario testing a retirement plan for a drop and prolonged suppression of house prices is one option. Of course that does not prevent the hardship, but it will help with setting proper expectations surrounding an individual’s retirement planning.
Market Timing Considerations and Net Worth One does not have to look back in history very far to see the consequences of declining equity prices on household net worth. The S&P 500 declined more than 50% peak to trough between October 2007 and March 2009. The S&P 500 hit 1,565 on October 9, 2007, and bottomed at 676.53 on March 9, 2009. This translated into a massive decline in equity. However, historically, equity markets have bounced back fairly quickly. With better economic news and accommodative easing, markets have recovered, and the trajectory of recovery has picked up steam. For example, if you invested
9
Five Threats to Your Retirement
The point we make here is that well-balanced portfolios tend to bounce back over reasonable time frames. Thus, although severe market moves may be painful and scary, they are less likely to be detrimental to a retiree’s net wealth in the long run.
Chart 12 Net Mutual Fund Flows into Bonds and Stocks 60 40 B Billions illions o off D Dollars ollars
in the Balanced total return portfolio in October 2007—in hindsight the worst time in the past 70 years to purchase equities, the portfolio would have returned more than 16% as of June 30, 2013 (this is a simple example using a hypothetical asset allocation). On August 2, 2013, the S&P 500 hit a new all-time high of 1,709, before pulling back on concerns regarding an eventual Fed tapering of quantitative easing.
Stocks Bonds
20 0 -20 -40 -60
In the wake of the 2007 financial crisis, there has been a persistent outflow of investment from stocks into bonds (Chart 12). While 2013 has seen some inflows into stocks, the Great Rotation—the asset allocation shift back to stocks from bonds by investors—is just starting to be seen. As we noted earlier, the flocking to fixed-income by investors in recent years had merit, given the strong returns experienced until recently.
2010
2010
2011
2011
2012
2012
2 2013 013
2013
Source: ICI, Morningstar, PNC Wealth Management
Chart 13 Net Worth of U.S. Households and Nonprofits 75
T Trillions rillions o off N Nominal ominal D Dollars ollars
To be clear, the ride has been bumpy, and while from a technical perspective the recent rally makes sense, it is our view that investors continue to feel some apprehension. The disconnect centers around the tangibility of economic recovery. While clear in some areas, it is sluggish in others. There are continued concerns about quantitative easing and future Fed policy in the United States and globally about a slowdown in China, among other issues.
70 65 60 55 50 45 40
Finally overall we note that despite the challenges households 35 have faced in terms of declining net worth, whether in investment 1 1999 999 2 2001 001 2 2003 003 2 2005 005 2 2007 007 2 2009 009 2 2011 011 portfolios, home prices, or other asset dislocations, net worth has now fully recovered and exceeded its prerecession highs (Chart 13). Source: Federal Reserve, PNC Wealth Management Our discussions here note the importance of asset allocation in totality to position an investor’s portfolio for various scenarios. For example during the financial crisis, when stock market valuations eroded portfolios, at least on paper fixed income provided a salve to investors with cash needs. A long-term approach works best, in our view, in positioning portfolios for near-term and long-term market and economic scenarios.
2013 2013
The PNC Financial Services Group, Inc. (“PNC”) provides investment and wealth management, fiduciary services, FDIC-insured banking products and services and lending of funds through its subsidiary, PNC Bank, National Association, which is a Member FDIC, and provides certain fiduciary and agency services through PNC Delaware Trust Company. This report is furnished for the use of PNC and its clients and does not constitute the provision of investment advice to any person. It is not prepared with respect to the specific investment objectives, financial situation or particular needs of any specific person. Use of this report is dependent upon the judgment and analysis applied by duly authorized investment personnel who consider a client’s individual account circumstances. Persons reading this report should consult with their PNC account representative regarding the appropriateness of investing in any securities or adopting any investment strategies discussed or recommended in this report and should understand that statements regarding future prospects may not be realized. The information contained in this report was obtained from sources deemed reliable. Such information is not guaranteed as to its accuracy, timeliness or completeness by PNC. The information contained in this report and the opinions expressed herein are subject to change without notice. Past performance is no guarantee of future results. Neither the information in this report nor any opinion expressed herein constitutes an offer to buy or sell, nor a recommendation to buy or sell, any security or financial instrument. Accounts managed by PNC and its affiliates may take positions from time to time in securities recommended and followed by PNC affiliates. PNC does not provide legal, tax or accounting advice. Securities are not bank deposits, nor are they backed or guaranteed by PNC or any of its affiliates, and are not issued by, insured by, guaranteed by, or obligations of the FDIC, or the Federal Reserve Board. Securities involve investment risks, including possible loss of principal. ©2013 The PNC Financial Services Group, Inc. All rights reserved.