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By Jason Stipp | 07-01-2011 05:24 PM

A Supplemental Portfolio Checklist for Retirees

Retirees should also consider inflation, longevity, liquidity, and transition planning as they check their performance, allocations, and progress, says Christine Benz.

Jason Stipp: I'm Jason Stipp from Morningstar. As you're pulling out your personal checklist and conducting your midyear portfolio review, Morningstar's Christine Benz has an extra checklist for those of you who are in retirement or nearing retirement, a special list of important ingredients for retirement portfolio success. She's here with me to offer the details.

Thanks for joining me, Christine.

Christine Benz: Jason, great to be here.

Stipp: So it's an extra checklist of things you should keep in mind if you're approaching retirement or you are in retirement. The first one is certainly a timely one. It involves inflation. It's something that we've seen creep up here in the first half of the year. Why should this be one of the most important things you think about as retiree?

Benz: Right. And this isn't just an evergreen concern. This is really something retirees should always have in mind when managing their portfolios, and that's making sure they have an element of inflation protection in their portfolio. There are couple of key reasons. One is that, if you're no longer earning a paycheck through a job, you're probably not eligible for cost-of-living adjustments. You will get a cost- of-living adjustment in Social Security payments, but you won't get that necessarily in your investment portfolio. So you want to add an element of your portfolio that will tick up along with inflation.

The second big reason that you want that inflation protection is that if you have a large share of your portfolio in fixed-rate investments, that means that, as prices go up for stuff that you need to buy, the purchasing power from those fixed-rate investments is actually declining. So you want to add a measure of inflation protection to kind of overlay those fixed-rate investments.

Stipp: So inflation protection is obviously critical, but how do you execute that? What sorts of investments should you be looking at and how much of those investments?

Benz: Well, good question. We had a healthy debate at the Morningstar Investment Conference about the role of Treasury Inflation-Protected Securities in portfolios. All of the panelists agreed that TIPS are a great idea, but I think there was some concern about valuations in the TIPS market. But I do think, long-term, that people who have a large share of their portfolios in fixed-income investments, do want to have a component of TIPS in the portfolio; that's the most direct way to hedge against inflation. If you want a long-term way to outgun inflation, I think every retirement portfolio does need to include stocks because their growth potential is certainly better than fixed-income investments. They are the only thing that give you a fighting shot at outpacing inflation long term.

Stipp: So TIPS, for example, look like they might be pricey right now, but you do want them as part of your strategy. One way could be to perhaps dollar cost average into that asset class.

Benz: I think so. I think that definitely makes sense. So that's a good way to go about it to buy regular installments of TIPS or a TIPS fund. Vanguard's fund as well as the PIMCO fund are Morningstar's favorites.

Stipp: So Christine, you kind of mentioned this a little bit in your answer on inflation, but another big thing to keep in mind as retiree is longevity. It could be retirement is a multidecade prospect hopefully for lot of us. What should you be thinking about with longevity?

Benz: This is just a way of making sure that your portfolio has staying power, and so, the key thing is to stress-test your withdrawal rate. So, if you are getting ready to retire, make sure that your plan, distributions, and retirement are sustainable over a period of many years. Plan for the best; plan for a good long life. And that might mean that you can't take out as much as you thought you might be able to. That might mean that you need to defer retirement. But it's better to address that issue before you start retirement and dig yourself into a hole than later on when it's too late.

So, consider assessing the longevity and the staying power of those withdrawal rates, and again I think I would come back to stocks as a must-have ingredient for every retiree portfolio in terms of meeting those longevity needs. There's nothing else that will give your portfolio that growth boost that stocks can.

Stipp: So stocks in your asset allocation is one way to address the staying power that your portfolio might need to have. There are also products that are specifically geared toward longevity, insurance basically.

Benz: There are.

Stipp: What do you think about those?

Benz: I think they are actually a terrific idea. So the idea is that it's easy to plan for a noble time horizon. So I might plan for my life expectancy, whether it's 85 or 87 or whatever it might be. So, I plan to make my retirement portfolio's distributions last through that period and then buy that longevity insurance that will kick in when I exceed that estimated longevity rate for my own life span.

So, I think it's an interesting product. People want to shop around. I think, insurance companies are increasingly coming out with products to help address that need. So you do need to do some comparison shopping. You really need to read up on what you're getting into, but I think it's a really interesting product type.

Stipp: So you have longevity on one side, that needs some special consideration, but then you also have the here and now, your immediate needs. What should you be thinking about on the liquidity front?

Benz: Well, liquidity is absolutely essential for retiree portfolios, and the key reason is that if you are taking money out of your portfolio on an ongoing basis, you don't want to be taking that money out of investments that are gyrating around. So, stocks and even bonds are not places where you want to be able to go for ready cash. You need to have that cash fund set aside.

So, I think one to two years' worth of living expenses is a good starting point for retirees to think about. Given how low cash yields are, maybe one year in true cash and another one year in, say, a short-term high-quality bond fund is a good starting point for that liquidity component of the retiree portfolio.

Stipp: Having that liquidity could help you mentally as well as physically actually outlive a downturn in the market. So 2008, for example, it wasn't necessarily that people held stocks in their portfolio but they held too much stocks perhaps, and they had to sell some of them at the worst time to meet those liquidity needs.

Benz: Exactly. So you're right. It's kind of a mental buffer. It's a way to keep your cool amid market gyrations because you know that the money you need for your near-term expenses is stashed away and safe. It's not fluctuating.

Stipp: You're not forced to sell some assets of the absolute worst time. Christine, another thing I think that we've been talking about a lot is the structure of the portfolio, how many investments you have, and how streamlined it is. The simplicity, I guess, is one way of approaching the portfolio. How important is that for folks as they are getting on into retirement?

Benz: I think simplicity is just such a key and underrated ingredient of retirement portfolios, and the key reason is none of us really knows what will happen to ourselves from day to day. Things could take us out of commission for a short or long period of time, and we may not be able to manage our portfolios. So I think it really makes sense to run a portfolio that could manage itself for a time if need be. That's why I'm increasingly talking to retirees who are looking to instruments like broad-market index funds and exchange-traded funds for their portfolios because there is no manager there. There is no risk of getting stocked with an unwanted tax bill. You're getting a lot of broad-market diversification in just a handful of holdings, so I think that can be very appealing. So can all-in-one funds, so these are funds that bundle a lot of different investments under the hood of a single vehicle. A lot of the retirement-income products do just that and can be very effective building blocks of simple retiree portfolios.

Stipp: Another benefit of those types of investments is a lot of them tend to be pretty pure as far as the areas of the market that they are targeting. So if you have a strategic allocation, and you want to be able to be on autopilot for a little while, you'll know pretty much where these funds are going to be invested over a period of time.

Benz: That's absolutely right. You might get an element of rebalancing, or you often do with a balanced fund or some sort of allocation fund. There is usually some rebalancing built in, so you know that the 50-50 fund isn't going to suddenly shoot up to 70-30, and you haven't had time to rebalance. It will do that for you.

Stipp: Well, Christine, lastly, sort of related to that, is some of the ancillary things you really need to take care of to make sure that there is a follow-up plan for your finances should something happen to you. What are some of those key things?

Benz: Yes, so this is estate planning, and that's something that all of us need to engage in regardless of our age. But obviously, it becomes more important as we get further on in our age. So some of the key aspects would be making sure that you have that durable or financial power of attorney and health-care power of attorney. These are individuals who you selected to make important, financial, and health-care decisions for you on your behalf. A living will, obviously is important as well as a will that specifies how you'd like your assets disposed of once you're gone. You want to make sure that these are up-to-date and revisiting them as your circumstances change. I know I talk to a lot of retirees who say, "Ah, I made my estate plan 15 years ago. In the meantime, my kids have had kids. There have been a lot of changes."

It's important to revisit those plans to make sure that they reflect the life that you're currently living.

Stipp: All right, Christine, well, thanks so much for these extra special tips for retirees and thanks for joining me today.

Benz: Thank you, Jason

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

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