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Midyear Portfolio Checkup: 4 Retiree To-Dos

Tue, 14 Jul 2015

Make sure you have enough liquid reserves, check the big-picture asset allocation, take stock of your withdrawals, and evaluate your portfolio's interest-rate sensitivity, says Morningstar's Christine Benz.

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Video Transcript

Jason Stipp: I'm Jason Stipp for Morningstar. As we head into the second half of 2015, it's a good time for retirees to open their portfolios and see where they are. Joining me with some tips for that midyear checkup is Christine Benz, our director of personal finance.

Christine, thanks for joining me.

Christine Benz: Jason, it's great to be here.

Stipp: You have four points for a midyear checkup for retirees. The first is to check those all-important liquid reserves. This is what you call bucket number one. What am I looking for when check my cash allocation?

Benz: Well, you are looking at the allocation itself. I typically recommend at least six months to two years' worth of living expenses in true cash instruments. I think the thing that you don't want to do if you're using the bucket system is you don't want to wait for that bucket to be completely depleted before you fill it back up. Ideally, you're filling it up with income distributions from your longer-term holdings as the months go by, and you may also be periodically refilling that bucket one with rebalancing proceeds by trimming some of your winners. So, keep an eye on that--see where you are with that bucket number one. Or if you're not using the bucket system, just make sure that you have adequate liquid reserves set aside.

The real virtue of that is when the bond or stock markets or both become volatile, you know that you have those near-term living expenses parked in cash. So, you're looking at the size of that allocation, but you're also looking at the yield that you're earning with that piece of your portfolio. A lot of investors have just gotten used to looking at that piece of their portfolio and thinking, "This is dead money--I won't earn any yield at all."

I can't say yields are great at this point, but we have seen yields pop up a little bit to the point where now, with some sort of an online savings bank account, you can earn a yield in the ballpark of 1%. That's not tremendous, but when you consider that a very high-quality short-term bond fund may be yielding just a touch much more than that with some interest-rate sensitivity, I think that that high-quality savings-account option doesn't look so bad with its 1% yield.

Stipp: It's funny how 1% can look good. The second point on a midyear checkup list is to look at the rest of your allocation. So, this is the longer-term part of your portfolio. What should I be checking there at this point?

Benz: You want to be checking that big-picture asset allocation--that's going to be the key determinant of how that long-term piece of your portfolio behaves. We've been evangelizing about the importance of rebalancing, but I do think this volatility that investors have experienced over the past month or so is a wake-up call to scale back on your equity exposure. It's been a great run, but it seems to be probably in the late innings for the current equity-market rally. It's probably a good policy to take some of your winnings, take some equities off the table, and plow them into safer securities--high-quality bonds and perhaps cash.

Stipp: Point number three has to do with retirement withdrawals, and there are a couple of points here. The first one is where you are taking those withdrawals, and there are a couple of considerations to that.

Benz: Right. And I always say that, as you are taking withdrawals from your portfolio, if you're using rebalancing to help fund your withdrawals, that you try to be strategic about where you go for sourcing those withdrawals. I think about how I help my mom manage her portfolio when we have to take her RMDs at year-end, usually. We're always going to whatever has performed best in her portfolio. I think that's a wise policy for retirees who are sourcing their distributions as well.

It's also really smart to keep an eye on which account types you are taking those distributions from. The name of the game is to try to take RMDs--which you have to take--while also trying to keep yourself in the lowest possible tax bracket. So, this is an area where we've seen some financial advisors and tax advisors stepping up and saying, "Retirees, we'll provide you this service if you're not really comfortable with tax management; we'll help you figure out how to source those withdrawals." That may be a good strategy for a retiree who isn't comfortable figuring this out. That tax planner or financial advisor may be able to help with that part of the job.

Stipp: What about my withdrawal rate? What should I be checking there?

Benz: Midyear is a great time of year to check in to see where you are versus your withdrawal-rate target. If you are running a little bit high relative to that target--and, of course, unplanned expenses inevitably crop up--it's a great idea to think about course-correcting in the last six months of the year. If you've gone a little bit over where you might have intended to go with your withdrawal rate, you can try to scale back your expenses in the last six months of the year.

Stipp: And if I'm in retirement, I likely have a big chunk of my portfolio in fixed income. So, the last thing that you say is important to check is the rate sensitivity of that part of my portfolio.

Benz: Right. Earlier this summer, we did see a fair amount of volatility in more interest-rate-sensitive securities. Here, I would urge retirees to do that duration stress test that we've talked about before with their fixed-income holdings. I've written an article on this topic, but the basic idea is that you find duration and you find the SEC yield for each of your bond funds. This will really only yield a meaningful result with high-quality bond funds. You subtract that SEC yield from the duration. The amount that you're left over with is the rough amount you would see that investment lose in a one-year period in which rates rose by one percentage point.

So, run your holdings through this process, but don't ignore the potential interest-rate sensitivity of your equity holdings. One thing we saw in this little bit of a stutter for interest rates earlier this summer was that we saw utilities perform very poorly, we saw REITs perform poorly, and we saw MLPs perform poorly. So, take a look at some of those securities--make sure that you're comfortable with the interest-rate sensitivity that could come along with them.

Stipp: Certainly set those expectations depending on your holdings. Thanks so much, Christine, for these midyear checkup tips for retirees.

Benz: Thank you, Jason.

Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.

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