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A Portfolio Built for the Next Decade | Financial Advisors

This Nov. 9 marks the 402nd anniversary of the Pilgrims’ first glimpse of the New England coastline. And while Plymouth, Massachusetts was not the original destination choice for the Mayflower passengers – it was actually northern Virginia – their journey to America was marked by, among other things, remarkable courage, curiosity and a willingness to quickly adapt to their new surroundings.

At first glimpse, the investment landscape for financial advisors today appears to be characterized by more problems and less promise. The current investment landscape includes both high inflation and the low probability that we’ll emerge from the Federal Reserve‘s rate hikes – five and counting so far this year – without an economic recession of some kind.

Beyond these gray clouds, though, remains an investment ecosystem that is typically resilient and often thrives on innovation and adaptability. According to data from Bloomberg, Lipper and BlackRock, the 10-year rolling returns of large U.S. companies in the S&P 500 were positive nearly 95% of the time from 1931 through 2021. As such, with a spirit similar to that of Mayflower voyagers, financial advisors can approach portfolio construction for their clients with a bit more optimism. Here are three investment strategies that can help your clients over the next decade:

  • Speak investors’ language.
  • Don’t ditch the 60/40 just yet.
  • Look into alternatives.

Speak Investors’ Language

Speaking of strategies, did you know that investors have preferences on how they like to discuss their investments with financial advisors? According to field research conducted by Invesco Consulting and Maslansky + Partners, 40% of investors prefer the word “strategy” over “solution” when it comes to investment management conversations. The word “solution” conveys a problem to investors. On the other hand, the word “strategy” sounds more constructive to investors.

It’s also important to develop investment strategies that reflect investors’ feedback. According to new research from the Transamerica Center for Retirement Studies, 56% of American workers say that saving for retirement is their top financial priority.

In a 2022 BlackRock survey, 64% of American workers say they are concerned about not having enough savings to last through retirement. And 80% want help to get through retirement – not just reach it.

Don’t Ditch the 60/40 Just Yet

This year, the Federal Reserve has sought to pare back inflation with five successive rate hikes; we now have an effective fed funds rate in the 3% to 3.25% range. And anytime the Federal Reserve raises rates, it typically creates volatility in the market. In fact, through September, we’ve experienced the worst market performance among both stocks and bonds since 1969, with the S&P 500 down nearly 24% and the Bloomberg U.S. Aggregate Bond Index down about 15%.

For near-retirees and retirees who will need both income and growth from their investment portfolios over the next decade, this kind of market volatility has raised additional questions about whether the traditional framework of roughly 60% in stocks and 40% in bonds still makes sense. After all, stocks and bonds are often highly correlated and move in the same direction in periods of high inflation, which diminishes bonds’ hedge protection if stocks turn sour.

Still, Fran Kinniry, principal and head of Vanguard’s Investment Advisory Research Center, believes there’s a viable role for the 60/40 investment approach: “Balanced portfolios have had an incredibly difficult year, and Vanguard’s view is that recession is likely within the next year; however, the beginning of a recession is usually accompanied by bond prices going up and yields going down, particularly at the longer end of the maturity spectrum. This could mean fixed income resuming its role as a buffer for equities.”

Risks abound on both sides of this paradigm, though. Sure, stocks can be volatile at times, but what if a retirement investor misses out on the growth they may need in the next decade – especially the kind that preserves purchasing power – by not having enough stocks in their portfolio? Kinniry adds, “In difficult market environments such as these, portfolio performance can be stressful, but the trade-off to temporary emotional discomfort is the greater likelihood of meeting long-term return objectives. While the future may not represent the past, since 1928, a 60/40 balanced portfolio has never experienced a 20-year period with negative real returns.”

Vanguard revised its 10-year outlook in October for core assets across the globe:

Asset Class 10-year Projected Return
U.S. stocks 4.1% to 6.1%
U.S. bonds 3.1% to 4.1%
Non-U.S. stocks 6.6% to 8.6%
Non-U.S. bonds 3.0% to 4.0%
U.S. real estate investment trusts 3.9% to 5.9%
Cash 2.6% to 3.6%

Adam Hetts, global head of portfolio construction and strategy for Janus Henderson Investors, adds: “A portfolio built for the next decade should be animated by the paradigm shift we’re witnessing this year. Since the Global Financial Crisis in 2008, we had to wrestle with rock-bottom interest rates and a world dictated by TINA – There Is No Alternative (to equities). Not only is there now a reasonable alternative to equities again in fixed income, but a broadly diversified equity investor should be reconsidering many of the stocks that were out of favor in recent memory. This includes many of the value-oriented, high-dividend stocks generally more common outside the U.S. In an environment characterized by high, persistent inflation, equity investors are well served to remember that the majority of real returns in equities have historically been driven by dividend yield and dividend growth.”

Look Into Alternatives

Others, like Rob Almeida, global investment strategist for MFS Investment Management, point to the potential headwinds for equity returns in the coming decade. He says, “Monetary policies are working to reduce aggregate demand (i.e., inflation). Higher costs – capital, labor, even ESG-related – combined with a multiyear overdue bill of capital investment will result in a very different, likely lower, profit margin structure versus the prior decade. Companies unable to both absorb what will be higher structural costs and a return to pre-COVID 19-trend economic growth will struggle to meet investor expectations.”

Perhaps that’s why alternative investments are starting to gain some traction among financial advisors. According to Cerulli Associates, financial advisors currently allocate 14.5% of the investment portfolios they manage to alternatives of some kind. Some of the alternatives that financial advisors use now include liquid alternative mutual funds (68%); non-traded REITs (61%); private equity (41%); and private debt (39%).

Beyond the potential for above-average returns, alternative investments can also help investors achieve broader diversification. Alternative investments often have low correlations to stocks and bonds.

One potential drawback is that alternative investments generally carry higher expense ratios than more traditional investments, like stock mutual funds and exchange-traded funds, or ETFs. According to the U.S. Securities and Exchange Commission, “Many alternative mutual funds have an annual fee equal to 2% or less of the fund’s assets.” By comparison, Morningstar reports that the average asset-weighted fund fee for mutual funds and ETFs is now 0.40%. In fairness, though, some of the higher costs for alternative investment strategies are related to such things as due diligence on privately held companies, investments with liquidity constraints and overall risk control.

Much has changed in the investment landscape this year – not all of which has been negative. The 10-year total-return outlook for bonds, for example, has almost doubled this year to more than 3%. Why does that matter? For an investor who needs a total return of 5.5% to sustain their retirement income needs for the next decade and beyond, bonds can now help with the required heavy lifting in the portfolio. In normal market periods, bonds are less volatile than stocks. This dynamic also allows for broader portfolio conversations about potential excess returns from other asset classes over the coming decade.

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