A Golden Age for Retirees?
Next year may not be an ideal time to switch your retirement strategy from growth to cutbacks, i.e. from stocks to bonds. But by the standards of modern history, that’s pretty good. On the other hand, if you’re approaching retirement and invested in U.S. stocks, your portfolio is probably worth a lot more than you expected. The inflation-adjusted real returns of the S&P 500 SPX over the past 15 years are in the top 20% of all returns since World War II. On the other hand, bond yields have risen sharply recently, so you could use your increased savings now to buy a higher-than-usual guaranteed lifetime income.
Unprecedented Stock Market Gains
In other words, the baby boomer generation is back on its feet. For a generation that peaks at age 65, with more than 11,000 estimated to retire every day, the combination of strong past stock returns and good future bond returns is coming at just the right time.
I don’t recommend anyone change all of their investments from stocks to bonds at once. This usually happens slowly, over years or even decades. But every deal happening now is happening on more favorable terms than ever before. The stocks you’re selling are expensive and you’re in a seller’s market. The bonds or annuities you’re buying are cheap and you’re in a buyer’s market.
The stock market benchmark, the S&P 500, delivered an impressive return of 28% in 2024, followed by 26% in 2023. The market can double your money in five years and has delivered double-digit gains in 11 of the past 15 years. (Apart from the occasional dip like in 2022.)
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Contrary to how it might feel, this is not normal.
Since at least the 1920s, large U.S. stocks have earned an average of 6.6% a year plus inflation.
And since World War II, the S&P 500 has averaged about 200% return over 15 years from inflation, plus price appreciation and reinvested dividends.
The past 15 years: 400% on top of inflation. Twice the average.
Analysis of data
Our analysis of data compiled by Yale finance professor Robert Shiller shows that this is in the top 20% of outcomes since 1945.
As the chart above shows, in the past these 15-year returns have tended to come and go in waves. Those retiring in the early 1960s, or in the late 1990s, were sitting on similar gains or even more. Those who retired in the 1970s and ’80s, or a decade ago: not so much.
And those arguing that the S&P 500 isn’t expensive at current levels are generally forced to fall back on arguments that “this time is different” or — as one big Wall Street bank put it recently — this time “breaks the rules.”
Sir John Templeton famously said that the words “this time is different” were the most dangerous in investment history.
Currently, the S&P 500 sells for 22 times forecast earnings, according to FactSet. So far this millennium it has only previously sold for this much or more, in relation to forecast earnings, during the peak years of 2000-’01 and 2020-’21. All proved with hindsight to be bad years to buy stocks and good years to sell them.
A Bond Market Bonanza
Meanwhile, what are we to make of bonds? Inflation-protected U.S. Treasury bonds, or TIPS, the cornerstone of a risk-free retirement-income portfolio, end the year offering yields, or interest rates, well over 2% above inflation. Five-year TIPS bonds are guaranteed to pay out inflation plus 2.04%; 10-year TIPS bonds, 2.24%; and 30-year TIPS bonds, 2.44%. These numbers are either good or excellent by historical standards, depending on whom you ask.
TIPS bonds did not exist before the 1990s. But since 1928, someone who bought regular 10-year U.S. Treasury bonds and held them for 10 years ended up earning an average return of 1.6% above inflation. (This comes from data compiled by the New York University Stern School of Business, with MarketWatch calculations.) The median, midmost return was just 0.8% a year above inflation.
Regular bonds, whose payments are fixed and do not fluctuate to reflect rising prices, are notoriously at risk from inflation. Those who bought Treasury bonds lost money in real, purchasing-power terms most notably in the 1940s and 1950s and in the 1970s.
TIPS bonds with guaranteed, inflation-protected interest rates of inflation plus 2% or better look very good by the standards of history, although of course there is no guarantee that there won’t be even better opportunities in due course.
Bonds work like seesaws: The price and the yield move in opposite directions. TIPS bond yields have risen while the prices have fallen.
The Rise of Annuities
The simplest way to secure risk-free income for the rest of your life is through a lifetime annuity, a policy bought from an insurance company that converts a pile of cash into the equivalent of an old-fashioned pension. It pays out until you die, and there is nothing left over for your heirs. The terms available on these policies fluctuate with the bond and interest-rate markets, because the insurance companies use bonds — Treasury and investment-grade corporate bonds, usually — to create the policies. As a result annuity rates are also looking pretty good, especially when compared with their lows a few years ago.
A 65-year-old man can lock in a 7.7% return for life, meaning a monthly income of $640 out of a $100,000 investment, at current rates. A 65-year-old woman would get a 7.3% return, or $610. (Women get less per month because they are likely to live longer, and therefore collect more checks.)
Those payouts are nearly 30% higher than they were in the summer of 2021, before pandemic-era inflation took off and bonds collapsed. You can also buy annuities with annual cost-of-living adjustments, to protect against the erosion of your purchasing power over time, though these are typically much more expensive.
Quantifying the Opportunity
We should quantify how good this moment is for anyone contemplating retirement. Historically, anyone who owned a broad portfolio of large U.S. stocks could sell them for an average price of 16 times the most recent 12 months’ earnings, according to Shiller’s data. Today you can sell your S&P 500 index fund for 28 times the most recent earnings, or about 75% more than average.
Meanwhile, in the past those plunging their money into U.S. Treasury bonds ended up earning 1.6% a year plus inflation over the following decade. Today you’re getting 2.24% a year over inflation, or 40% more.
Put the two together, and the retirement terms of trade — if you want — are overall about 140% above historic averages. Whether the numbers get even better in the future, or get worse, will be another matter.
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