Market Update: Is Your Nest Egg Safe?
Filbrandt & Company Reports
Volume 21, Issue 20
Report Summary:
- Rebalance your portfolio to reduce risk
- History points to a balanced approach in your portfolio allocations
- Assessing risk can be challenging for professors for 3 reasons
"Someone's sitting in the shade today because someone planted a tree a long time ago."
-Warren Buffett
Stay the Market Course or Adjust Your Sails?
As many university leaders near retirement, they begin to prepare themselves for the next phase in life. Three factors have been the most impactful: the power of time, disciplined contributions to university benefits plans, and the steady returns of the stock market. When we look at the returns of the S&P 500, the average annualized return over the past decade has been a healthy 13 percent[1]. Staying the course over the long-term and having exposure to equities has been beneficial. However, uncertainty now lies in the expectation of inflation and a more hawkish Fed, the ongoing pandemic, and a market that may be “due for a correction.”
Renowned economist and Professor of Economics at Yale, Robert Shiller recently said, “The prices of stocks, bonds, and real estate—the three major asset classes in the United States—are all extremely high. In fact, the three have never been this overpriced simultaneously in modern history.”[2] The cyclically adjusted price to earnings ratio (CAPE), the valuation method Shiller helped create, is at the second highest level since 1881, measuring in at 37.1 (as opposed to the average 17.12). Stocks appear to be the second most expensive they have ever been.[2] Reason for caution, September 2021 proved to be the worst performing month for the S&P 500 since March of 2020[3]. It is a great time to consider your portfolio’s risk exposure, especially if nearing retirement.
Know Your Risk Exposure
To reduce risk, start by rebalancing your portfolio. Rebalancing your portfolio is the process of adjusting your proportion of asset weights back to their original targets. For instance, if you have targeted 60 percent of your portfolio assets in equities and that has since grown to 80 percent, rebalancing back to sixty adjusts your weighting appropriately. Academics who have not had time to tend to their portfolio recently may have more equity exposure than originally targeted, given the increases experienced over the years. Further, the original targets may no longer be appropriate as retirement nears and goals shift.
Identifying appropriate risk targets can be tricky for professors:
- Numerous Accounts: Most faculty members have a core plan they are participating in plus any supplemental programs. They may also have retirement accounts from previous posts or other niche pieces of the puzzle.
- The Big Picture: Even with a good grasp of the various accounts, rarely are the allocations coordinated with a spouse’s investments or other outside brokerage assets. Considerations like keeping costs low, tax-sheltering, and understanding how different accounts can work together to create a unified approach is vital.
- Target Date Funds: These funds are becoming more prevalent in university-sponsored plans. In theory, this one-stop shop simplifies investing. In practice, many individuals invest in multiple plans and sometimes select an inappropriate retirement date without considering outside investments.
History Points to a Balanced Approach
As individuals edge closer to retirement, they typically want something predictable and conservative. Achieving balance in portfolio construction over the long-term can provide comfort and reduce volatility. Looking at the chart below during a five-year, ten-year, or twenty-year time horizon, a 50/50 stock-to-bond portfolio has not lost money. In fact, the 50/50 approach did slightly better than a 100% bond portfolio over the most recent rolling five-year time horizon.
Navigating a variety of factors when constructing an appropriate portfolio can be daunting. There is no paint-by-numbers approach, especially with the complexity of numerous investment accounts. Factors to consider: developing a cohesive approach for various accounts, setting reasonable risk parameters as you edge closer to retirement, and creating replacement income from that portfolio as you enter retirement.
Acknowledging the current tax environment, upcoming changes could have an impact on investment decisions for professors earning significant salaries. Congress is proposing a significant increase to capital gains rates next year by raising the 20% rate to 25% and retaining the 3.8% surtax, for a total of 28.8%.[4] With valuations high and for those with significant capital gains to consider, now could be the perfect time to rethink your approach. You’ve grown your nest egg over decades. Now protect what you have worked so hard to save.
[1] https://www.businessinsider.co..
[2] https://www.nytimes.com/2021/1...