Saving and investing for retirement requires clients to be steadfast in their contributions and stay the course when market volatility tests even the most patient of investors.
Unfortunately, volatility has been increasing in frequency and magnitude and return expectations are projected to be lower in the future than over the last five years.
Clients, therefore, will need to save more or invest differently to reach their retirement goals. With this backdrop, it may be prudent to consider incorporating an equity strategy for clients that can potentially deliver stronger, more intentional returns and lower overall risk to address these investing challenges.
60/40 Challenge
Returns for a traditional 60% equity and 40% fixed income portfolio are expected to be muted moving forward. Northern Trust Asset Management projects U.S. stock returns to average 4.7% annually over the next five years, versus the 10.8% growth they have averaged annually over the last five years.
Much has been discussed regarding diversifying fixed income strategies to boost return and lower interest rate risk in a 60/40 portfolio, but what about the equity portion of one's allocation?
Increasing equity allocations to lift expected portfolio returns may feel a bit precarious for many investors nearing or in retirement, especially with volatility increasing. It might sound counterintuitive, but one way to mitigate risk and market volatility is through the use of a quality low volatility (QLV) strategy.
Benefits of QLV
Low-volatility stocks tend to experience a narrower range of returns than the market as a whole. Further, our research shows that low-volatility stocks have historically outperformed the broad market on a risk-adjusted basis.
By investing in such stocks, clients are less likely to endure severe market drawdowns or declines and are less likely to panic and abandon long-term investment goals when markets are in turmoil.
Our research also shows that investing in companies that are of the highest quality — those with strong cash flows, profitability and management efficiency — may further mitigate market declines and potentially improve performance.
Enhancing 60/40 With QLV
In the illustration below, we examine the comparison of a 60/40 portfolio versus that of a "de-risking 1.0" portfolio, where equity allocations are reduced by 10% in favor of bonds, to demonstrate what a traditional risk reduction strategy does to portfolio returns.
