Tue, 11 Aug 2015
Morningstar's Christine Benz suggests that as investors enter retirement they focus on certain parts of their financial plan such as inflation protection and consider deprioritizing other needs such as life insurance.
Jason Stipp: I'm Jason Stipp for Morningstar. Retirees have heard that they need to play up bonds and play down stocks in their portfolios. But there are also some other areas of your financial plan that you might want to play up and play down. Here to offer some insight is Morningstar's Christine Benz, our director of personal finance.
Christine, thanks for joining me.
Christine Benz: Jason, it's great to be here.
Stipp: You brought a list of "do more" and a list of "do less" in retirement to help people organize and change as they might need to do as they enter retirement. Let's start with the do more. The first one is longevity and long-term-care protection; you need more of these in retirement. Let's start with long-term care, since this is a big issue that retirees face.
Benz: It is a big issue because if you face very large long-term-care costs late in life, it could completely eat away at everything that you've managed to save. It could leave less in place to take care of your spouse and other loved ones. And if leaving a legacy for your kids or grandkids or charity was part of your plan, it could gobble up all of those assets, too. So, it's really important to think ahead and make sure that you have put in place some sort of plan for long-term care.
Stipp: And how you do that? What are your options for that kind of insurance? Or is insurance the only option?
Benz: Well, this is a big topic. We could devote a whole video to it, really; but certainly long-term-care insurance is an option. One of the things that is lingering out there, though, is that premiums have gone up; many people who have purchased the insurance, thinking it was the right thing to do, have been faced with extremely high premium increases. So, that has been a risk factor for long-term-care purchases. Even on a starting basis, the insurance isn't cheap.
So, that's an issue certainly. If you've run the numbers and determined that you're not going to insure the long-term-care risk, you at least need to make sure that Medicaid would cover you if you depleted all your assets and that you're comfortable with that idea of depleting all your assets. If not, then you need to make sure that you've set aside some sort of a fund for long-term-care needs; make sure that you've been realistic about how much you need to set aside for long-term-care expenses, should they arise. And make sure that you've segregated that money from your other assets--that is, the money that you plan to spend during retirement or pass on to your heirs.
Stipp: Another thing you want to protect against and do more of is longevity protection. Retirement can be a multidecade period of time for a lot of people. How do I make sure that I'm not outliving my assets?
Benz: One of the best ways to make sure that you have some longevity protection in your financial plan is simply to have a healthy stock component as part of your portfolio, because when you think about expected returns from various asset classes, bond returns and cash returns probably aren't going to be great over the next decade or even longer. Stocks, even though they are not especially cheap today, do probably give you the best long-run shot at growing your portfolio a little bit in retirement, if not just keeping up with inflation. So, you need to make sure that you have equities in your portfolio. You might also consider some sort of annuity product that pays you that lifetime stream of income and gives you that hedge against having a very long life. I would say folks who have pensions and Social Security--lifetime-income sources that provide them with most of the income that they'll need that will last throughout their lifetime--they would be less-worthy candidates for any sort of annuity product. People without those products, though, might consider some sort of annuity.
Stipp: Another thing that you say retirees need more of versus folks still in their working years is cash. Why do I need more cash after I'm retired than before I'm retired?
Benz: When you're still working, I think what you really need is just some sort of an emergency-expense buffer to get you through in case you lose your job or have some big unplanned expenses. When you're retired, I do think it's a best practice to make sure that you're running with some sort of a cash component in your portfolio; I usually say anywhere from six months to two years' worth of cash.
The basic idea is that, by having that cash component--which is kind of the linchpin of the bucket strategy that we often talk about--your long-term portfolio can do what it's going to do. You know that you have at least a couple years' worth of living expenses set aside to fund your income needs. You can regroup if your long-term portfolio doesn't behave as you expect it to. Or if you're using a more income-centric strategy, there may be some disruptions in your income stream. If you have that cash set aside, that gives you time to regroup, too.
Stipp: And when you say cash, you mean cash.
Benz: I mean true cash. I often get questions from readers and viewers who say, "Can I use a bank-loan fund instead of cash? Can I use a short-term bond fund instead of cash?" When you are thinking about the properties of cash and what the key value of cash is, it's that principal stability--that idea that the money you put in cash will not fluctuate at all--whereas all of these other investment types could see some fluctuation in their principal values.
Stipp: Next you say, "I'm moving into retirement--I need to think about getting more inflation protection."
Benz: Right. This is a topic that we've often talked about. One of the key reasons that you need inflation protection is that if you are steering more and more of your portfolio into fixed-rate investments, that means that the income from those investments is going to be eroded as inflation ticks up. Of course, inflation has been really benign for the past several years; but it's still important, in my view, to be forward-thinking, anticipate that inflation could tick up. And also, in retirement, you may have higher inflation costs than are reflected in CPI. If a big part of your consumption basket is health-care costs, for example, those may be running a hotter rate than the Consumer Price Index.
Stipp: When I'm looking for inflation protection, I'm looking at what kinds of investments generally?
Benz: Here, again, stocks give you a good shot at outrunning inflation. Then, you might also look at some more-specialized investment types--Treasury Inflation-Protected Securities is a category that we've talked about. That certainly makes sense as a bolt-on to your fixed-income portfolio, and also you might look at bank-loan investments. You might also look at commodities investments. Although their performance has been pretty darn poor recently, over long periods of time, I would expect them to provide some measure of inflation protection. I would just keep them to a small portion of the portfolio.
Stipp: Christine, something else you say retirees may want to do more of is take a look at their equity portfolio and maybe play up dividend-paying stocks. Why is that?
Benz: I think dividend-payers look good for retiree portfolios from a few different angles. One is that, as we've often discussed, yields from bonds are very, very low. Certainly, yields from cash are almost nonexistent right now. So, dividend-payers, in some cases, have higher yields than you are able to obtain from bonds and cash. That's one reason. The other reason is if you have equities in your portfolio at all, we'll typically see high-quality dividend-payers behave a little better on the downside than non-dividend-payers. So, if while you're owning stocks, you also want to add a little bit of stability to that equity portfolio, dividend-payers are, generally speaking, a good way to go about it.
Stipp: And individual dividend stocks versus dividend-paying funds--what's your thinking around one of those two?
Benz: Certainly, investors can do well with both strategies--the individual securities as well as a good-quality low-expense fund that buys dividend-paying stocks. I do think that older retirees who are thinking about being a little bit more hands-off with their portfolios should probably think about segueing a little more into some sort of a managed product; that way, they're not having to worry about so many moving parts.
Stipp: One more "do more" for retirees is diversification within their bond portfolios. What kind of diversification?
Benz: We've already talked about a couple of the categories. In addition to that core intermediate-term fund that carried you through your accumulation years, I think you want to start thinking about staging that portfolio to deliver you your cash flow during retirement. I usually think a short-term bond fund is a good addition to a retiree portfolio. TIPS, as we discussed. And then you might think about some of the more equitylike fixed-income types: bank loans, I would put in that category; perhaps some sort of a high-yield investment, or a multisector-bond fund, or an emerging-markets bond fund. But I certainly wouldn't use any of those more equitylike fixed-income types in place of that core high-quality fixed-income portfolio. I'd use them as additions at the tail-end of the portfolio.
Stipp: Christine, you also brought some things that retirees may want to think about doing less of. The first one might seem a little counterintuitive at first, but there are some reasons to take a look at your life insurance. You might not need as much in retirement as you needed before retirement.
Benz: That's right. It seems counterintuitive--and it might also be controversial. So, first, I would say that there are some reasons that life insurance can make a lot of sense in retirement--specifically in the realm of estate-planning. There may be some very good reasons to hang on to your life insurance. This is not a one-size-fits-all recommendation. But if you did own a baseline of life insurance to provide income replacement in case something happened to you to make sure that your spouse's and children's income needs were fulfilled, you might consider that if you're retired and drawing from your portfolio and no longer drawing an income, that's going to be a less-important need for you. It may be an expense that you can get away without having.
Stipp: Lastly, you say that retired investors should look at their equity portfolios and do less of those niche, very-concentrated funds--just because they are a lot more volatile, potentially.
Benz: That's right. Just as you are diversifying your fixed-income portfolio because it's getting larger, as your equity portfolio is getting to be a smaller slice of the pie, I think you can safely reduce your exposure to some of those noncore investment types. It might be that standalone emerging-markets equity fund or a very aggressive small-cap-growth fund or a biotechnology fund. Whatever it might be, I think that as your equity portfolio declines as a percentage of your total portfolio, I think you want to think about making it somewhat more conservative overall. Not entirely conservative, but you probably want to your equity portfolio a little bit more of a high-quality cast. The reason that you want to skinny down those noncore investment types is that, if your time horizon is shrinking--as it is as we all get older--you want to make sure that have time to regroup if any asset class suffers losses during your holding period. As your time horizon shrinks, you have less time to regroup from some of the big losses that can accompany these categories.
Stipp: Christine, some great "do more" and "do less" tips for retirees. Thanks for joining me.
Benz: Thank you, Jason.
Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.