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How Equities Can Reduce Longevity Risk

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How Equities Can Reduce Longevity Risk

Will You Outlive Your Savings?

The desire to live longer — and outrun death — is ingrained in the human spirit. The first emperor of China, Qin Shi Huang, may have even drank mercury in his quest for immortality.

Over time, advice for living longer has become more practical: eat well, get regular exercise, seek medical advice. However, as life expectancies increase, many individuals will struggle to save enough for their lengthy retirement years.

Today’s infographic comes from New York Life Investments, and it uncovers how holding a stronger equity weighting in your portfolio may help you save enough funds for your lifespan.

Longer Life Expectancies

Around the world, more people are living longer.

YearLife Expectancy at Birth, World
196052.6 years
198062.9 years
200067.7 years
201672.1 years

Despite this, many people underestimate how long they’ll live. Why?

  • They compare to older relatives.
    Approximately 25% of variation in lifespan is a product of ancestry, but it’s not the only factor that matters. Gender, lifestyle, exercise, diet, and even socioeconomic status also have a large impact. Even more importantly, breakthroughs in healthcare and technology have contributed to longer life expectancies over the last century.
  • They refer to life expectancy at birth.
    This is the most commonly quoted statistic. However, life expectancies rise as individuals age. This is because they have survived many potential causes of untimely death — including higher mortality risks often associated with childhood.

Longevity Risk

Amid the longer lifespans and inaccurate predictions, a problem is brewing.

Currently, 35% of U.S. households do not participate in any retirement savings plan. Among those who do, the median household only has $1,100 in its retirement account.

Enter longevity risk: many investors are facing the possibility that they will outlive their retirement savings.

So, what’s the solution? One strategy lies in the composition of an investor’s portfolio.

The Case for a Stronger Equity Weighting

One of the most important decisions an investor will make is their asset allocation.

As a guide, many individuals have referred to the “100-age” rule. For example, a 40-year-old would hold 60% in stocks while an 80-year-old would hold 20% in stocks.

As life expectancies rise and time horizons lengthen, a more aggressive portfolio has become increasingly important. Today, professionals suggest a rule closer to 110-age or 120-age.

There are many reasons why investors should consider holding a strong equity weighting.

  1. Equities Have Strong Long-Term Performance

    Equities deliver much higher returns than other asset classes over time. Not only do they outpace inflation by a wide margin, many also pay dividends that boost performance when reinvested.

  2. Small Yearly Withdrawals Limit Risk

    Upon retirement, an investor usually withdraws only a small percentage of their portfolio each year. This limits the downside risk of equities, even in bear markets.

  3. Earning Potential Can Balance Portfolio Risk

    Some healthy seniors are choosing to work in retirement to stay active. This means they have more earning potential, and are better equipped to recoup any losses their portfolio may experience.

  4. Time Horizons Extend Beyond Lifespan

    Many individuals, particularly affluent investors, want to pass on their wealth to their loved ones upon their death. Given the longer time horizon, the portfolio is better equipped to ride out risk and maximize returns through equities.

Higher Risk, Higher Potential Reward

Holding equities can be an exercise in psychological discipline. An investor must be able to ride out the ups and downs in the stock market.

If they can, there’s a good chance they will be rewarded. By allocating more of their portfolio to equities, investors greatly increase the odds of retiring whenever they want — with funds that will last their entire lifetime.

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Infographics

Retirement Savings: How to Calculate If You’re on Track

This graphic shows how to plan for sufficient retirement savings, and how the U.S. population measures up at each step.

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Retirement savings by age group, to help people gauge their own retirement planning. Retirement balances get bigger until age 65-74 and go down for those over age 75.

This infographic is available as a poster.

Retirement Savings: How to Calculate If You’re on Track

Setting a retirement savings goal can be overwhelming. In fact, one in three Americans have no idea what they need to save to retire at their target age.

Luckily, we can use a retirement calculator to help outline what you need to consider. This graphic from New York Life Investments walks you through setting your retirement savings goal, and shows how the U.S. population measures up at each step.

Step 1: Your Age

A calculator will typically start by asking for your current age and your target retirement age. This is to determine how long you have left to build up your investments. In the U.S., the average age of retirement has remained relatively stable and is currently 62.

Keep in mind that your retirement age can depend on many factors:

  • Your cost of living
  • Your job satisfaction
  • Your debts
  • Your spouse’s retirement plan
  • Your health

After you have your projected retirement age figured out, you’ll also need to estimate the length of your retirement.

The life expectancy for Americans at birth is 77 years. Once you’ve lived to age 65, that number is higher. This is because you’ve survived many untimely causes of death, including the higher mortality associated with childhood. The below table shows how the expected age of death changes as you age.

 At BirthAt Age 65
Male7482
Female8085
Both Sexes7784

To estimate your particular lifespan, you’ll also need to consider things like your genetics and your lifestyle. Having an idea of how long you might live may help you better manage longevity risk, or the risk you’ll outlive your savings.

Step 2: Your Savings

The next step in setting your retirement savings goal is to take stock of how much you’ve already saved. For context, here is how much Americans have saved for retirement by age group.

 Median BalanceAverage Balance
< 35$13,000$30,170
35-44$60,000$131,950
45-54$100,000$254,720
55-64$134,000$408,420
65-74$164,000$426,070
> 75$83,000$357,920

You’ll also need to decide how much you’ll be putting toward your retirement each year. Experts typically recommend saving about 15% of your pre-tax income. This can include your employer’s contributions, if any. Of course, this amount will vary based on how early you start saving and when you plan to retire.

Your expected investment earnings will play a big role, too. Here is what average annual returns have been for different types of portfolios based on historical data from 1928-2021.

 Conservative
(80% bonds, 20% stocks)
Balanced
(40% bonds, 60% stocks)
Growth
(20% bonds, 80% stocks)
Nominal Return8%10%11%
Real Return5%7%8%

Inflation has averaged about 3% each year. Remember to include inflation in your calculations so you can maintain purchasing power in retirement.

Step 3: Your Income

In the final step of setting your retirement savings goal, you’ll need to decide how much of your current household income you will use in retirement. Financial experts typically estimate you could need 70-80% of your pre-retirement income.

At this stage, it can be helpful to plan out a detailed budget. Here’s a spending overview for the average American over age 65.

CategoryAnnual Spending
Housing$17,435
Healthcare$6,668
Transportation$6,221
Food$5,698
Donations, Child and Spousal Support$3,119
Personal Insurance and Pensions$2,721
Entertainment$2,293
Clothing$821
Alcohol and Tobacco$635
Other$2,033

Other includes personal care products and services ($505), education ($450), reading ($157), and miscellaneous expenses ($921).

Now that you have an estimate of your expenses, you can factor in all sources of income you expect to receive in retirement. This helps narrow down what you need to have set aside in your retirement savings. For instance, most people collect Social Security in addition to their own pension. The below table shows what percentage of retirees have each income source.

SourceRetirees Age 65 and OlderAll Retirees
Social Security92%78%
Defined Contribution or Defined Benefit Pension66%57%
Interest, Dividends, or Rental Income49%43%
Wages, Salaries, or Self-employment25%32%
Cash Transfers Other Than Social Security7%11%

Respondents could select multiple answers. Sources include the income of a spouse or partner.

Based on all this information, a retirement calculator will estimate whether you are on track to sufficiently fund your retirement years.

Turning a Retirement Savings Strategy Into Action

It’s important to note that retirement calculators are a starting point. To come up with a customized strategy, you’ll likely want to consider:

  • Your current and expected tax rate
  • Increases in your income and savings rate
  • A contingency plan for unexpected events

However, retirement calculators can make the concept of retirement savings more concrete—and help you take action toward your goals.

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Infographics

Demystifying Three Bond Myths During Rising Rates

Contrary to popular belief, it’s not all doom and gloom for bonds during rising interest rates. Below, we dispel three myths to explain why.

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Bonds During Rising Interest Rates

This infographic is available as a poster.

Demystifying Three Bond Myths During Rising Rates

Today U.S. Treasury yields, a key return measure for bonds, are over 1% higher than pre-pandemic levels.

  • January 2020: 1.8%
  • May 2022: 2.9*

*As of May 17, 2022

While rising interest rates are often seen to have a negative impact on bonds, the current environment may be beneficial.

In this infographic from New York Life Investments, we debunk three common myths about bonds during rising rate environments to explain why.

Bonds During Rising Interest Rates

To start, here’s a brief introduction on how bond yields are affected by interest rates.

Bond yields are the return investors will earn from a bond over a period of time. Bond investors receive interest for purchasing debt issued by the government or a corporation. For instance, a $1,000 bond with a 3% yield would earn $30 annually.

Rising interest rates directly affect bonds.

When interest rates rise, bond yields typically rise. As investors seek out new bonds that provide higher yields (income), the demand for existing lower-yielding bonds declines. Consequently, the price of these existing bonds typically falls.

Given this backdrop, let’s explore how bonds have historically performed during rising rates, the potential buying opportunities they present, and their long-term performance in a rising rate climate.

Myth #1: “Never Hold Bonds During a Rising Rate Environment”

Answer: False

Even during multiple rising rate periods, bonds have shown positive performance in the last 38 out of 42 years. Let’s take a look at the two most recent rising rate periods:

Bond TypeJun 2004 - Jul 2006Dec 2015 - Jan 2019Average
Bank Loans5.90%5.20%5.50%
Short-Term Bonds2.90%1.10%2.00%
Long-Term Bonds5.60%2.70%4.10%
High-Yield Bonds8.40%7.50%7.90%
Municipal Bonds8.40%2.70%3.80%

Time periods measured from the first Federal Reserve rate hike until one month after the last rate hike, which, on average, is when the effective federal funds rate tends to stabilize.
Source: Morningstar (Feb 2022)

As shown above, every type of bond showed positive performance.

High-yield bonds returned the highest over the last two rising rate periods, averaging 7.9%. Not only that, when equities decline, bonds have often cushioned losses, as seen in the Great Financial Crisis and the COVID-19 market crash.

Myth #2: “This Is the Worst Time to Invest In Bonds”

Answer: False

Rather than doom and gloom, the current environment could present a buying opportunity. Consider how municipal (muni) bonds have performed after historically low periods:

Time PeriodPeak DateTrough DateDrawdown (%)Return (%) 12 Months
Following Trough
Fed Rate Rise (‘04 - ‘06)Mar 17, 2004May 13, 2004-5.298.65
Subprime Mortgage Collapse/
Global Financial Crisis
Jan 23, 2008Oct 16, 2008-11.2219.85
Meredith Whitney
60 Minutes Interview
Oct 12, 2010Jan 17, 2011-6.4615.2
Taper TantrumMay 2, 2013Sep 5, 2013-6.7710.22
Trump Election VictoryJul 6, 2016Dec 1, 2016-5.715.95
COVID-19Mar 9, 2020Mar 23, 2020-10.9413.18
Fed Rate Rise (‘22)Aug 4, 2021Mar 16, 2022-5.59?

Municipal bonds represented by Bloomberg Municipal Bond Index. Data is for the time period 1/1/1994 to 4/30/2022. Meredith Whitney is known as “The Oracle of Wall Street”. In 2010, when Whitney stated that many municipal bonds would default in 2010, it shocked the market.
Source: Morningstar (Apr 2022)

In the 12 months following each trough date, muni bonds rebounded notably.

For example, after falling over 11% during the Global Financial Crisis, munis returned nearly 20% in the 12 months after. Munis also could potentially benefit from other key factors including solid credit fundamentals and the $350 billion federal stimulus to state and local budgets.

Not only that as bond prices dip, a “buy low” opportunity may be present not only in munis, but other areas of the bond market.

Myth #3: “The Long-Term View Looks Dismal”

Answer: False

When taking a long-term perspective, investors could potentially generate more income from their bond holdings in a rising rate environment than they would have otherwise.

Here’s how investors can capitalize on rising rates as bonds mature, given the following assumptions:

  1. Every year, a maturing bond is replaced with a new 5-year bond.
  2. The yield is 20 basis points (bps) higher on each new bond.
ScenarioDescriptionAnnualized Return of Bond Portfolio
After 10 Years
Scenario 1Yields remain unchanged1.80%
Scenario 2Yields fall 100bps across the curve
during Year 1
1.10%
Scenario 3Yields rise 100bps across the curve
during Year 1
2.50%

Hypothetical example, for illustrative purposes only. One basis point is equal to 1/100th of 1%, or 0.01%, or 0.0001, and is used to denote the percentage change in a financial instrument.
Source: RBC Global Asset Management (2020)

Over the long term, a rising rate environment more than doubled the bond portfolio’s return compared to the falling rate scenario.

With this in mind, active management and a long-term strategy can potentially benefit investors during today’s rising interest rate environment.

Research shows that active approaches to fixed income have generally outperformed passive strategies by diversifying across the maturity spectrum while proactively balancing risk and return. Active strategies can seek out new opportunities as interest rates shift, addressing a broader scope of the bond market.

The Case for Bonds

With inflation and bond yields on the rise, purchasing newly-issued bonds at higher rates can help offset this impact. While bonds may not seem like the obvious choice for investors amid rising rates, history shows us that they may be worth a closer look.

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