Rethinking a 2023 rebalance as rate hikes remain

By David Byrnes

The Federal Reserve continues its effort to tame high inflation, and another announcement due later this month will likely deliver another rate hike. Many investors watched the bond markets destabilize in 2022 and remain understandably concerned. Cleveland Fed President Loretta Mester’s comments that January’s hike should have been higher, indicates are not out of the woods yet. Financial professionals should look to continued uncertainty, especially as volatility and investor concerns for the second half of the year remain high.

Inflation, rate hikes, earnings declines and an inverted yield curve will all factor into decisions that impact client portfolios in 2023. For many, the traditional 60/40 stock/bond portfolio mix has been the go-to investment strategy and has held up well for decades. However, financial professionals should consider fixed rate products as an alternative when talking with clients about what to do with the 40% dedicated to fixed income.

The past 12 months have challenged advisors to place client money, given that stocks and bonds both had an abysmal 2022 — the first time both market segments had negative years at the same time since 1994. Stocks were down near bear market levels (the S&P 500 Index was down -18.11%) and bonds were down nearly as much (the Bloomberg Aggregate Bond Index was down -13.01%). So far this year, the Bloomberg Aggregate Bond Index has eked out a 0.28% return but faces headwinds from additional rate hikes.

60/40 is no longer optimized

When seeking to optimize portfolios, advisors closely examine multiple asset classes with the aim of striking a delicate balance between risk and return. By diversifying across asset classes, and across holdings within each class, the portfolio can become more efficient — maximizing possible returns for a given amount of risk.

The typical 60/40 asset mix seeks to balance the greater return potential (and volatility) of stocks, with a more stable fixed income component like bonds (that generally offered less volatility in prices, plus interest potential). Because the bond component failed to deliver in 2022, and 2023 may be much the same, fixed rate annuities are an alternative to consider.

Multi-year guaranteed annuities can make sense for many savers in the current economic environment. As an asset class, they are non-correlated with equities, much like bonds, and therefore help to increase portfolio diversification. They help to de-risk client portfolios too, as there is no downside market risk given the principal guarantee.

MYGAs, in particular, offer a way to lock in the current high rates with longer-term contracts, typically 3-, 5-, and 7-year guarantee periods. Once the Fed pivots, and rates eventually do fall again, MYGAs will offer excellent, guaranteed accumulation potential, by delivering high yields for clients in a less than predictable marketplace.

Not the only option

MYGAs are not the only vehicle to consider. Fixed indexed annuities are another good bond alternative for savers to consider, especially with volatility in mind. Buying the dip is a common strategy with stocks, but if markets continue dropping after you buy, your clients may lose patience. FIAs give clients potential accumulation in the form of interest credits linked not to current rates, but to the performance of financial indices. And, as with MYGAs, there is no downside market risk.

Many FIAs offer a range of indices, giving advisors multiple ways to position client portfolios depending on how they perceive the direction of the markets. FIAs and MYGAs can be used interchangeably or together to help stabilize client assets while building retirement savings.

2023 planning

While lingering market volatility remains, financial professionals and their clients can use this time to their advantage to re-balance assets. As bond yields slow further, fixed rate products such as MYGAs are consistent alternatives for more predictable accumulation, as well as de-risking with downside protection. FIAs are another alternative that taps index-linked accumulation potential, again with no downside risk. These products also accumulate tax deferred, so 100% of the accumulated interest is compounded and untaxed until withdrawal.

Equity and fixed income markets moved with a bit more predictability in relation to one another until recently. In the near term, we may see a very different scenario unfold making it more challenging to optimize client portfolios. Financial professionals should set expectations with their clients and consider how they can take advantage of today’s higher rates with annuities.

David Byrnes is head of distribution at Security Benefit. He may be contacted at [email protected].