It's true that stocks are more volatile than bonds, but that doesn't mean retirees should avoid them, especially when interest rates are low. In this video, Michael Douglass and Matt Frankel discuss why stocks are a smart choice at any age and why bonds may not be as low risk as they appear.
A full transcript follows the video.
This video was recorded on Nov. 27, 2017.
Michael Douglass: Let's head over to myth No. 2: Retirees should always avoid stocks. This one is particularly potentially damaging, because so many retirees are relatively short on money, and stocks can help make a difference in retirement.
Matt Frankel: It's absolutely true that retirees should scale back their exposure to stocks. We're not saying that at all. I'm not recommending retirees have 80% of their money invested in the stock market. However, especially in a low-interest rate environment like we're in right now, where bond yields are 2% to 3% if you're lucky, it can be tough to even keep up with inflation over time if all you're invested in is fixed income or, even worse, cash investments. You're going to have some volatility in stocks. That's true. But, it's definitely a risk/reward thing where the reward makes more sense.
Douglass: Yeah. And the fact of the matter is, good quality, conservative dividend stocks provide a reasonably safe cushion. Dividend Aristocrats, which we've talked about a few times on this show, but just as a refresher, they are stocks that have raised their dividends at least once annually for at least the last 25 years. They're household names like Coca-Cola, Johnson & Johnson, companies that pretty much, not all of them, but generally a lot of people have heard of. These are companies that, theoretically, you can get a 2% to 3% dividend, pretty similar to what bonds are paying right now, and potentially there's some capital appreciation as the actual stocks hopefully increase in value over time as well. Of course, you have to pick good businesses. Don't just search for the biggest yield. But, there's an opportunity there for people who have a little bit more of a risk appetite.
By the way, if anyone listening still needs the list of Dividend Aristocrats, drop us a note at firstname.lastname@example.org. I shared an article about this a month or a month and a half ago, but anyone new or anyone who just didn't listen to that episode, feel free to drop us a note and I'll be happy to send that along. There's also kind of a mini-myth buried in this idea of stocks, which is that bonds are safe for retirees. And that's not always necessarily the case, either.
Frankel: There's a few reasons why this is a good mini-myth to debunk. First of all, bonds are like stocks in that there is a wide spectrum of risk within the asset class. The Dividend Aristocrats that Michael just mentioned, and buying a stock like Netflix or something even newer and riskier, that's two different things in terms of risk. Also, there's two other forms of risk you need to know. There's always some level of default risk, unless you're buying U.S. treasuries, which...
Douglass: Yield nothing.
Frankel: ...yield next to nothing, or, as interest rates rise, the actual dollar value of your bonds could fall. Now, if you buy a bond that's paying 3% for $1,000, you're going to get your $30 interest payment every year until it matures or until it's called. That's a given, that's not the risk. The risk is, as interest rates rise, and investors can now buy bonds that are paying 5% to 6% or more, that $1,000 face value of the bond can decline. Which, if you have to sell, can be a big problem. If you buy a 30-year Treasury and interest rates rise 2% or 3%, the face value of that bond could be down to $600 or $700, not $1,000, pretty easily. So, that's a big risk. Again, generally, bonds are not as volatile as stocks, and your interest payments are much more secure than the dividends of even the most secure dividend stocks. But there is that default risk and the interest rate risk that investors need to be aware of.
Douglass: Particularly given that interest rates, over the coming few years, look poised to actually increase. Now, if you asked any serious stock market watcher three years ago, they probably all would have said the same thing. But, it looks like the Fed is actually beginning to hike interest rates, so it looks like we're going to head toward a higher-interest rate environment. Not necessarily a high-interest rate environment by any stretch, but higher than it's been. We've been in a historically low-interest rate environment pretty much since the Great Recession.
Matthew Frankel has no position in any of the stocks mentioned. Michael Douglass owns shares of Johnson & Johnson. The Motley Fool owns shares of and recommends Johnson & Johnson and Netflix. The Motley Fool has a disclosure policy.