For many people approaching retirement, the final five to ten years before the transition are critical. At this juncture, you have fewer working years ahead, but often your highest earnings and the largest pool of savings. The challenge is to grow those savings without taking on risks that could derail your plans. Here is a two-part investment strategy using bonds and high performing mutual funds to help achieve these goals.
Part 1: Separate your savings into two allocations – a medium risk bond portfolio and a high growth mutual fund
Investment products with “maximum growth potential” tend to have higher levels of risk. With retirement on the horizon, you may not wish to have 100% of your life savings in high risk (high growth) products. Investors should consider allocating their savings between a medium risk bond portfolio and a higher growth product. The bond portfolio can act as an attractive tool to reduce your overall risk while still achieving some growth. The income produced by this portfolio can be used to invest in your allocation towards higher growth/ higher risk products such as mutual funds. In this way, the bond portfolio will act as a floor for your return and create more stability in your returns.
Today, investment-grade sovereign and corporate bonds are yielding between 4% and 5.5%. These bonds are considered low risk. High Yield bonds are yielding anywhere between 6% and 7% (with a minimum credit rating of BB-). These yields EXCLUDE capital appreciation. In a declining interest rate environment (such as the one we are currently in), bonds also present the opportunity for capital appreciation. Year to date, the US Corporate High Yield Bond Index has risen by 7.2% in price and the US Investment grade Bond Index has increased by 6.5%. This is in addition to the income you earn on the bonds. The growth in prices of your bonds further enhances your total return.
Part 2: Reinvest income from bond portfolio into growth focused Mutual Funds
Growth focused Mutual funds give you exposure to diversified portfolios of bonds or stocks. Allocating a portion of your savings to mutual funds allows you to tap into medium and long-term growth opportunities. You want to look for a mutual fund with a strong track record that invests in assets that are liquid, sound and creditworthy.
Enjoy up to 40% total growth with the power of compounding
Consider this example. You invest a pool of $250,000 today and you aim to earn 7% compounded over the next 5 years across a mutual fund investment and the bond portfolio. All income from your bond portfolio goes into the mutual fund. If you earn 7% per year compounded annually over 5 years, you will have US$350,637.93 at the end of the period, roughly 40% more than your starting sum. If you earn 8% per year compounded annually, you will have roughly US$367,332 at the end of the period, roughly 47% more than your starting sum. Try to ensure the bond portfolio generates a weighted average yield that is at least equivalent to your target return.
Final Thought
How to split your allocation is a function of your tolerance and appetite. There are traditional financial frameworks that give guidance on these allocations, and your advisor can guide you through. The years just before retirement offer a unique opportunity. By blending bond security with mutual fund growth, and by reinvesting income for compounding, you can make these years some of the most productive for your wealth.
Marian Ross-Ammar is Vice President, Trading & Investment at Sterling Asset Management. Sterling provides financial advice and instruments in U.S. dollars and other hard currencies to the corporate, individual and institutional investor. Visit our website at www.sterling.com.jm
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This article was written with the assistance of Artificial Intelligence.