Many retirees face the greatest risk in the years leading up immediately to retirement. They haven’t yet begun collecting some of the more stable benefits like Social Security, which can help protect their portfolio against market downturns. Also, they no longer have many years ahead to rebuild their portfolio from losses. And if a recession hits in their early 60’s, many simply will put off their retirement for several years. This is known as sequence of returns risk. And one strategy to protect yourself against it is a bond tent. Here’s what you need to know.
If you want to minimize risk and protect your nest egg, a financial advisor can walk you through specific options for your retirement needs.
What Is a Bond Tent?
A bond tent is named for the shape it makes in your asset distribution chart. With a bond tent, your goal is to protect your retirement fund from volatility during the years immediately before and after retirement, while also preserving your opportunity for long-term growth. As you approach retirement, you shift your portfolio’s asset balance in favor of bonds so by the time you retire, your portfolio holds a majority of these secure instruments.
Then, during the first several years of your retirement, you take much of your income from the bond section of your portfolio. This provides you with relatively stable withdrawals, and automatically rebalances your portfolio back toward equities and other growth investments.
For example, take a hypothetical 55 year old investor. They hold an aggressive portfolio of 80% equities and 20% bonds. Over the next 10 years, as they approach retirement, they would steadily sell their stocks and buy bonds. By age 65, they hold a portfolio of 40% stocks and 60% bonds. They are now much less exposed to a market downturn at the time of retirement.
In their early years of retirement, then, this investor focuses on spending down their bonds first. They gradually rebalance their portfolio toward stocks, perhaps reaching a balance of 60% equities and 40% bonds by age 75. The result forms a “tent” on this investor’s allocation chart, with their bond holdings peaking at retirement and declining on the other side.
Why Use a Bond Tent?
The value of a bond tent is its mix of security and growth. On both sides of your retirement, your portfolio needs a decent mix of growth-oriented investments. Leading up to retirement, you want to build the wealth that you will retire on. Then, in retirement, you’ll want to continue growing that wealth to maintain your lifestyle, while hedging against both longevity and inflation risks.
After all, you don’t want to find yourself relying on Social Security in your 80s because you spent down the 401(k).
However you also need to protect yourself against volatility during the early years of your retirement, when you haven’t yet begun to take distributions and don’t have Social Security to hedge your income.
If a recession hits at age 64, you might find yourself forced to choose between delaying your retirement and cashing out assets that have lost significant value.
This is where a bond tent comes in. It allows you to weight your portfolio in favor of low-risk, low-volatility assets during the years immediately surrounding your retirement. This significantly reduces the risk that a bear market will force you to change your plans. If a recession does hit, you will likely be able to rely on your bonds while your equities take time and regain their value. At the same time, though, the equity-heavy sides of your tent allow your portfolio to grow during times when you are less exposed to volatility, giving you a mix of security and growth.
Risks to a Bond Tent
Of course no strategy is foolproof. A bond tent has several potential downsides associated with it. One is the risk exposure of your in-retirement equity holdings. While rebalancing toward equities in retirement can give you potential growth to extend the lifetime of your portfolio, this also exposes your portfolio to market risks. If a recession hits while you hold 60% equities, your retirement accounts will take heavy losses. You might be able supplement that with your remaining bond holdings and Social Security, but it’s important to make sure that you can do so.
This strategy also depends on your bonds holding their value.
The last several years have been characterized by rising interest rates, which is good for new bond purchases but undermines the value of existing bond portfolios. If your bonds lose their market value when you need to rebalance toward stocks, you may find yourself having to choose between long-term growth and short-term losses.
These aren’t necessarily reasons to abandon the bond tent as a strategy, but it’s important to remember that like its eponymous chart, this strategy has both up- and down-sides.
A bond tent is an investment strategy designed to protect your retirement plans against sequence of return risk. It involves creating a bond-heavy hedge in your portfolio during the years leading up to your retirement, so that you don’t have to change your plans in the event of a recession.
Investing Tips for Beginners
- If you want to learn more about bonds and understand why this asset is a popular low volatility investment, this guide breaks down how they work.
- A financial advisor can help you build a comprehensive retirement plan. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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