Preserving Wealth During Market Uncertainty: Using a Bond Buffer

June 10, 2022

A Bond Buffer strategy uses bonds to protect your assets during a market downturn, providing a stable pool of assets to fund your spending needs and help you avoid liquidating investments at a loss.

Once you’ve accumulated sufficient assets to meet your financial goals, a logical next step involves a transition toward preserving that wealth. How can you protect the savings you have spent years building so that it continues to fund your ongoing, annual spending needs?

Consider the Value of a Bond Buffer

During periods of economic and market uncertainty, it is natural to worry about the value of your stock portfolio. One of the biggest fears investors have—especially as they approach retirement—is that market losses will undermine their ability to meet their future financial needs or goals.

During periods of market volatility and higher inflation, it can be helpful to consider steps you can take to preserve wealth and feel more confident about your future.

A Bond Buffer strategy uses bonds to protect your assets during a market downturn. It works by allocating a portion of your portfolio across a diverse mix of highly rated, short-term bonds. This approach can provide a stable pool of assets to fund spending needs and help you avoid selling stocks at a loss—allowing time for those securities to recover their value.

Take a Long-Term View

Driven by emotion, investors often sell when prices drop (panic selling) even though selling at the wrong time can be detrimental to the long-term health of your portfolio. For example, investors who sold stock at the March 2020 low not only missed the subsequent steep recovery, which returned 71.92% through the end of the year, but they also locked in those losses, negatively impacting the long-term value of their portfolios.1 

Planning for a Market Downturn discusses how individuals who resist the urge to sell are more likely to achieve their long-term goals. In fact, those who stay invested tend to achieve higher returns over the long-term than those who cash out altogether or exit the market near its lowest point and reinvest a year later (Figure 1).

The image illustrates the value of a $100 investment in the stock market during the period 2006-2020. Data sources: Strategic Capital Investment Advisors. The market is represented by the Russell 3000 Index. Cash is represented by the 30-day U.S. Treasury bill. An investment cannot be made directly in an index. The data assumes reinvestment of income and does not account for taxes or transaction costs. This is for illustrative purposes only and not indicative of any investment. This information has been taken from sources, which we believe to be reliable, but there is no guarantee as to its accuracy. For index definitions please visit http://mfinwealth.com/index

Preserve Your Spending Power

Selling stocks at the wrong time can lead to permanent loss of spending power. However, with a Bond Buffer, you can liquidate bond holdings to fund necessary distributions, allowing time for stocks and other asset classes to recover. As shown in Figure 2, a $1,000,000 Bond Buffer allocation can support over 12 years of $100,000 withdrawals without resorting to selling other holdings. Keep in mind that this time horizon may not be necessary, as the average bear market in stocks lasts only 10 months (Figure 3).  

Assumes a $1,000,000 allocation to a Bond Buffer with returns equal to the yield to maturity on 2-year Treasury bonds as of 6/22/2022. Illustration further assumes that withdrawal amounts are fixed at $100,000 over time and taken at the end of each year. 

Sources: Dimensional Fund Advisors. S&P data ©2022 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. In USD. Chart end date is December 31, 2021; the last trough to peak return of 119% represents the return through December 2021. Due to availability of data, monthly returns are used January 1926 through December 1989; daily returns are used January 1990 through present. Periods in which cumulative return from peak is –20% or lower and a recovery of 20% from trough has not yet occurred are considered Bear markets. Bull markets are subsequent rises following the bear market trough through the next recovery of at least 20%. The chart shows bear and bull markets, the number of months they lasted and the associated cumulative performance for each market period. Results for different time periods could differ from the results shown. A logarithmic scale is a nonlinear scale in which the numbers shown are a set distance along the axis and the increments are a power, or logarithm, of a base number. This allows data over a wide range of values to be displayed in a condensed way. Past performance is no guarantee of future results. Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio. This information has been taken from sources, which we believe to be reliable, but there is no guarantee as to its accuracy. For index definitions please visit http://mfinwealth.com/index

Improve Your Potential for Long-Term Success

As discussed in Goal-Based Investing: An Introduction, an important part of building an asset allocation strategy involves utilizing conservative investments like high-quality bonds to meet current spending needs. An appropriate Bond Buffer allocation may offer an effective way to address this objective, reduce investor anxiety, and preserve wealth during a stock market decline. This is especially important early in a retiree’s income distribution phase when realized market losses could have a significant impact on overall portfolio longevity. To determine whether a Bond Buffer strategy can help support your goals, consult with your trusted financial advisor.

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This material and the opinions voiced are for general information only and are not intended to provide specific advice or recommendations for any individual or entity. It has been prepared without regard to the financial circumstances and objectives of individual investors. The appropriateness of a particular investment or strategy will depend on an investor’s individual circumstances and objectives. To determine what is appropriate for you, please contact your M Financial Professional. Information obtained from third-party sources are believed to be reliable but not guaranteed Diversification does not ensure a profit or protect against loss in a declining market. M Financial Asset Management, Inc. (M Wealth) is a registered investment advisor, and a division of M Financial Group. © Copyright 2022 M Financial Group. All rights reserved. #4802726.1 Expires 6/2024