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Federal Reserve chief Jerome Powell, shown speaking virtually at the central bank’s Jackson Hole symposium, says tapering could begin by year’s end.

Daniel Acker/Bloomberg

News that the Federal Reserve could begin trimming its bond-buying program later this year shouldn’t affect the retirement-saving strategy of young workers, but those nearing retirement might want to shift away from fixed-income investment vehicles, including long-term bonds, advisors say.

Federal Reserve Chairman Jerome Powell, speaking last week at the central bank’s annual symposium in Jackson Hole, Wyo., said the Fed is considering a plan that would begin a gradual wind-down of $120 billion in purchases monthly of Treasury securities and mortgage-backed securities, perhaps as soon as this fall. The purchases were launched early in the pandemic to help keep interest rates low.  

It’s uncertain when tapering will begin and how quickly the Fed will scale back its asset purchases. But Christine Armstrong, executive director for wealth management at the Armstrong Group at

Morgan Stanley,

said tapering may start as early as September, sooner than most economic analysts expect, potentially leading to a stock-market decline of 10% to 15%. 

Factors such as the rapid spread of the Delta variant of the coronavirus and the expiration of federal unemployment benefits for those affected by Covid-19 also may contribute to a stock-market pullback, Armstrong said. Though no one knows when the Fed will increase interest rates from their historic lows, tapering represents the “first step” toward raising rates, so fixed-income bonds are unappealing right now, she says.

“Absolutely, we expect a drawdown this fall, which would be normal in the course of a regular market,” Armstrong says. “We don’t see it as being particularly upsetting or anything like that.”

Investors endured a taper tantrum in 2013, when the Fed chairman at the time, Ben Bernanke, surprised markets by announcing the central bank would begin tapering its bond-buying program that began during the financial crisis. Tapering meant there would be less demand for Treasuries, so bond investors reacted by selling bonds, driving yields higher while the value of bonds fell. From May 1 through the end of 2013, the 10-year Treasury yield rose sharply to 3.04% from 1.66%, while many bond values finished the year in the red. 

If a similar situation plays out this fall, Armstrong says, fixed-income bond funds and similar investment vehicles favored by low-risk retirement savers could suffer. “Bonds are going to be out of favor,” she says, “so any bonds you own, you’re getting hit with huge headwinds on them. It’s going to be hard to make money in bonds.”

Though the stock market did decline during the 2013 taper tantrum, the dip was “short and fast,” says Ben Barzideh, wealth advisor at Piershale Financial Group, and equities quickly recovered. For younger workers, who typically have most of their 401(k) or other retirement savings in equities, the potential for another market decline due to tapering isn’t a reason to adjust their saving strategy, he says. 

“Younger people are more insulated,” Barzideh says.

For older workers, Barzideh says, bonds remain a necessary part of their retirement portfolio to protect against a sharp market downturn. It’s hard to predict the Fed’s timetable, he says, but he saw tapering of roughly $15 billion a month in asset purchases likely to begin in December or January, adding that a big taper tantrum is unlikely because the Fed has “done a relatively good job of managing expectations and setting the scene, so people know it’s coming.”  

“Certainly, we would never recommend that older people reduce their bond holdings due to this,” he says. “They may want to reduce some of their longer-term bonds and add a little bit more to medium-term or even short-term bonds if bonds are getting hit pretty bad.

“Bonds can do OK in periods where interest rates are rising, whether it’s due to tapering or the Fed raising interest rates, but it’s definitely a headwind.” 

Rather than investing in traditional fixed-income bonds, he says, older workers might want to consider Treasury Inflation-Protected Securities, or TIPS. The principal of TIPS rises with inflation, as measured by the consumer price index. 

As for equities, Armstrong said retirement savers should consider banks and other financial-services companies, whose margins on loan products would improve if interest rates eventually climb. 

Daniel Milan, managing partner of Cornerstone Financial Services, said older workers seeking lower-risk investment vehicles should consider floating-rate funds, which have a variable interest rate tied to a benchmark rate. 

“We really don’t want clients in traditional fixed-income bonds, whether it’s corporate or Treasuries, because when interest rates go up, the market value of those bonds is going to go down,” Milan said. 

He also likes blue-chip stocks that pay dividends and real estate investment trusts, which can act as hedges against high inflation rates. He likes large-cap equities such as

Home Depot

(ticker: HD),

Lowe’s

(LOW),

PepsiCo

(PEP), and

Coca-Cola

(KO) that reliably pay dividends.

“If you’re going to go the equities route to provide income rather than the traditional fixed-income route, you want them to be safe,” Milan says. “You’re looking for blue chips, or Dividend Aristocrats—companies that have consistently paid dividends for over 25 years. We specifically target companies that historically have grown their dividends on an annual basis at a rate that’s higher than inflation.”

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