Conventional wisdom says that retirees should maintain a significant portion of their retirement assets in bonds. Depending on your age, this portion might range from 40% to 75%. The objective of a higher bond allocation of course is to reduce the overall risk to your portfolio. These days though higher bond allocations don’t feel quite so safe.
Some time in December 2008 yields of 5 year US Treasury bonds dropped to 1.52% and hit a low around .62% in July 2012. This is the lowest yield on the graph, which goes back to 1962. I guess this is understandable given the level of financial turmoil at the time. But as the graph from the St. Louis Fed shows, yields on 5 year treasuries have remained at or below 2.5% ever since. (Link to the graph and data: FRED data 5 year US treasury yields.) As of January 15, 2015 the yield is 1.22%. These persistent low yields present a significant problem to retirees who expect income from these bonds to provide for their daily expenses.
Low bond yields have been engineered by the Federal Reserve as a mechanism to stimulate economic growth and investment. The Fed’s signals some eighteen months ago that the end of quantitative easing was in sight unleashed the “taper tantrum” of 2013. The St. Louis Fed took the taper tantrum as a sign of the effectiveness of Fed policy. For the St. Louis Feds’ take on this, see “Lessons from the Taper Tantrum”. But today, the expectation of the Fed’s imminent interest rate boost seems to have had no effect on yields. And US equity prices appear to be maintaining their upward trajectory. So what does all this signal?
I look at this from the point of view of meeting retirement needs rather than an attempt at an economic explanation for what has happened or might happen. However, all of us have to clarify expectations for the future in order to decide what to do at a very practical level—stay with current bond allocations or not. Are low rates a more or less permanent condition? Will rates jump next year? You have to take a stand. I am asking myself as I prepare for 2015 what, if any, changes I should make to my allocations. I don’t have answers yet.