Bond market isn’t what it was. Here are some strategies to help protect your nest egg

Stocks rightfully deserve attention for what they have contributed to building financial security for people over the past 40 years. Over this time, employer-provided pensions have become rare, making it essential for people to take responsibility for their own investments through employer retirement plans, individual retirement accounts and other opportunities.

Many of today’s 60-somethings are transitioning to retirement with a lucrative assist from stock market returns, which have continued to post new all-time high marks this year.

But investing in stocks can expose investors to a wide range of fluctuating performance along the path to realizing strong long-term returns. The volatility can make many investors uncomfortable. For less go-for-it investors, or for people transitioning to retirement and becoming more focused on income than growth, over the past 40 years there have also been effective ways to add some defense to your investment strategy while still generating attractive returns. Government and corporate bonds commonly provided income that easily outpaced inflation. That income typically was paid with little threat of decline to the original principal of your investment.

In 2021, and seemingly for the next several years, however, playing defense in your portfolio will be harder. More than 80 percent of currently issued bonds around the world yield less than 2 percent annual income.

With inflation trending upward for the first time in years, there is a real threat that income from bonds won’t keep up. You could reach for more income by investing in higher-yielding “junk” bonds, but they currently do not compensate investors at a level that is compelling compared to the increased risk they present.

This has caused an increasing suggestion from investment strategists that someone who might have previously invested in a balanced portfolio of 60 percent stocks and 40 percent bonds might now need to increase stock weight to 70 percent or more to remain positioned for the type of return they expect on their money. Others invested with lower weight in stocks might need to consider a similar shift.

Some conservative investors who aren’t comfortable increasing the weight of stocks in their portfolio, will have to reluctantly change expectations. Rather than accept more risk, conservative investors might need to reduce expected spending to offset the shrinking returns from bonds.

Aside from increasing the weight of bonds as a form of defense against potential downside risk of stocks, there are ways that investors can reduce risk.

First, though, you need to have a clear picture of how much risk you are exposed to. Most people have no quantitative measure of the riskiness of their investments. Evaluating measures of risk can sometimes be done with tools available from your account custodian. Otherwise, data from websites like portofliovisualizer.com or Morningstar.com could help.

Being mindful of the downside potential in your portfolio is very important. Once you’ve experienced a sharp decline, it’s too late to decide if you are uncomfortable with it.

In addition to knowing what can go wrong, you should consider what actions you would take in response. How much flexibility do you have to adapt spending expectations, increase savings rate, defer retirement dates (if you’re still working)? These or other adjustments could allow you to accept less aggressive positioning of your investments.

A first step to reduce aggressive positioning could be to simply diversify stock holdings. Individual stocks have a wider range of potential outcomes than holdings like broad-market mutual funds or exchange-traded funds. Broadening your holdings, perhaps emphasizing companies with higher quality in their financial performance, and de-emphasizing speculative growth stocks, can decrease risk. This type of diversification is a form of defense that will limit upside potential since you won’t be concentrated in an investment that may happen to perform well, but it will keep you from the detrimental impact of investments that fail to thrive.

Another form of defense that allows you to keep most of your money positioned for growth is a bucketed approach. Segment the money you expect to need to use in the next 1-3 years into a separate bucket without stock market exposure. Such funds should be in cash or short-term bonds to protect their value for your known expenses. Knowing that your short-term needs are covered might help you endure the fluctuations in your longer-term money.

Most of these thoughts about risk management would be covered in any reasonably thorough financial plan, or at least a documented investment strategy. A plan that assigns purpose and clear objectives to your money could help you understand how much defense should be built into your strategy.

With a well-defined strategy in place, you will be less likely to fall victim to the whims of a moody market. It will help you make informed decisions when the investment world deviates from your ideal scenario.