The role of fixed income in retirement

Investors have different goals depending on their stage of life, but for those entering the retirement phase the focus will usually be on three things:

1. Finding a way to replace their salary with cash flow from other sources;
2. Aiming to preserve capital; and 
   
3. Protecting their investments against market falls.

Having a truly diversified portfolio can help in achieving these goals. Over the long-term, diversification should provide investors with better risk-adjusted returns, and greater peace-of-mind around meeting all of these objectives.  We believe that a well-diversified, actively-managed fixed income fund can play an important role in a client’s overall investment strategy. This is because bonds aim to help reduce volatility, maintain capital preservation and provide income generation and diversification. We explore the role of fixed income in retirement in more detail below.

A liquid means of earning income

A retiree or someone heading into retirement typically needs an investment strategy designed to provide a predictable and reliable income stream throughout their retirement years. This fits naturally with how bonds provide regular coupon payments, and how a bond fund can further diversify any risk by investing in many different issuers and industries. Bond funds also typically provide daily liquidity where the underlying investments are investment-grade rated.

Volatility and risk management

A well-managed bond fund can also help retirees generate attractive returns whilst seeking to manage volatility and mitigate risks. For this reason, bond funds may have a role to play as an income stream within a retirement portfolio, diversifying the portfolio’s overall risk and complementing commonly-used income options like investment properties and dividend-paying stocks.

Diversification in an overall portfolio

When considering portfolio allocations, it’s important to consider how different assets may behave in different scenarios. Bonds have the potential to help preserve capital within an overall portfolio, as they typically provide a positive return when the value of growth assets is falling – this is why bonds are described as a defensive asset. Bonds also tend to be much less volatile than growth assets, providing stability in times when markets do not.

Aiming to preserve capital

As clients approach retirement they become increasingly exposed to sequencing risk – this is the risk of retiring during a market downturn such as the global financial crisis. Retirees are especially sensitive to sequencing risk, as withdrawing capital to fund retirement during falling markets means they don’t have the luxury of time to recover the capital lost. This increases the risk of them outliving their capital and may mean they are forced to return to work to rebuild savings and/or reduce their standard of living in retirement. An allocation to fixed income has a dual benefit for these clients, through both providing an income stream for their retirement, and providing some insulation to the risk of significant drawdowns on any growth exposures they may hold elsewhere in their portfolios.

All investments carry some type of risk

As with most investments, bond funds do still carry investment risk, and, although steps are taken to try and minimise this risk, clients should be aware that returns from bond funds are not guaranteed.

Conclusion

Retirement planning decisions are complex, and while there is no single solution for all situations, a well-diversified, actively-managed bond fund can play a very important role in a client’s overall investment strategy, assisting investors by seeking to provide a consistent income stream in retirement while also providing a greater degree of capital stability in periods of market volatility.

The ‘lower-for-longer’ interest rate theme continues to dominate markets, and low yields are likely to see low returns from bonds for a period of time, but with the potential removal of franking credits, which will remove a key income stream for retirees, bonds continue to provide excellent portfolio diversification by reducing portfolio volatility, whilst providing a stable source of retirement income.