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By Christine Benz | 06-22-2012 01:00 PM

Tackling the Retirement-Income Challenge

Premium Member Video: Financial experts John Ameriks, Sue Stevens, and Bill Bernstein address how to allocate fixed-income assets, the importance of total return, the role of annuities, retirement distribution rates, and more in this special panel discussion hosted by Christine Benz.

Christine Benz: I am Christine Benz for Morningstar. I'm director of personal finance. And this panel is called tackling the retirement-income challenge. The challenge, of course, is that it's very difficult to wring a real income stream from a portfolio these days without taking a lot of risk on. So I am happy to say that we have a very able panel here to offer varying perspectives on this important set of issues.

John Ameriks is here from Vanguard. He is on my far right here on the stage. John leads the firm's investment counseling and research group. He is also a principal at the firm, and he is on the investment committee for several of the firm's funds, including the managed payout funds. I wanted to put in a little plug for some of the research that Vanguard does in terms of planning and retirement. I know it's been a treasure trove of information for me personally, and if you haven't gone on Vanguard's site to check it out, I would urge you to do so. That is the output from John and his group.

Sue Stevens is also here from Stevens Wealth Management in Deerfield, Ill. Sue is a longtime friend and contributor to Morningstar. She has earned many, many honors over the years for her work as a planner, and she also has a very long array of designations after her name. She is a CPA, a CFA, a CFP and an MBA, and we're very happy to have Sue here.

Finally Bill Bernstein is here all the way from Oregon. Bill is an asset-allocation theoretician, and I've learnt a lot from Bill and have his books on my bookshelf which include the Birth of Plenty, The Investor's Manifesto, and The Four Pillars of Investing. He is also a neurologist. So we have a lot of overachievers up here today.

The thing I want to kick off with is something that keys in on Jeremy Grantham's presentation, and I know that many of you saw it. Jeremy described bonds as disgusting. And we are all here to talk about what retiree portfolios should look like, and we all think of bonds as mainstays in retiree portfolios. So, I'd like to hear from this panel about what role fixed income should play in portfolios for retirees. Is the standard asset-allocation advice about tipping more and more of the portfolio into fixed income still worthwhile? Bill, let's start with you because you do spend lot of time focusing on asset allocation, specifically.

Bill Bernstein: Well, the purpose of bonds in your portfolio is as a safe asset. They are what let you sleep at night. They are to be there when you want to buy cheap stocks. They are there to pay your living expenses. They are there for emergencies. They're there to buy that corner lot that your impecunious neighbor owns who is now in financial trouble because of the crisis; you've always had your eye on that lot.

They're not there for yield. The famous phrase goes that 'there has been money lost chasing yield than has ever been lost at the point of a gun.' And I think that we're going to find that's going to be true in the next several years. The main thing is safety. At the end of the day, there are risky assets, and there are riskless assets. And whatever you do, don't confuse the two.

Benz: Bill, so just to follow-up on that, your prescription for fixed-income allocation for most retirees would be to keep it fairly safe and keep it short, correct?

Bernstein: That's right, yes. You know, a long bond, even if it's a Treasury, is not a safe bond. It's been that way for the past 30 years, but I don't think it's going to be that way going forward.

Benz: Sue, how about for you and your practice in terms of allocating client assets? Is your take similar to Bill's that you sort of use [bonds] as ballast for the equity portfolio, or where do you come out on that?

Sue Stevens: Well, I think I'm similar to Bill in thinking of bonds as being the portion of your portfolio that is sort of the safety mechanism in there, though everything has caveats, so nothing is really safe, and especially right now. But maybe just to build on some points that Bill made, I think one of the things you want to be thinking about is just the depth of diversification in the bond side of your portfolio. And I know probably for a lot of you out there who are advisors, you're hearing from your clients that they just don't understand bonds at all. There's a real disconnect there.

So, helping them understand the difference between a corporate bond and a government bond or the role of high yield in a portfolio I think can add value. It may not be as straightforward as just buying one intermediate index right now if you're trying to help them diversify, not for yield only--I think that would be the smallest reason you do it--but more so from a safety perspective. If you listened to some of the panelists [at the Morningstar Investment Conference] the last few days taking about the role of Treasuries going forward, I think you have to really think about that if that's 50% of your index.

And maybe another thing to add to that is just we hear a lot about investing your age bonds, and I think there is variations on that. I think that's a good place to start. But I think as I look at my clients, and I think about lots of different objectives for them, there might be reasons why you would deviate from that. It might be that you have a legacy issue that you want to make sure that you're funding.

I think you want to think carefully about how much you want in fixed income versus equities, and then I think you want to think about the nature of your equities. If you do have a chance to get more [income] in the way of dividend-paying types of stocks, then maybe you just look at it in totality when you're trying to help your clients.

Benz: So, Sue, from a practical standpoint, when you think about client portfolios and their allocations, would you say you have ratcheted down fixed income a little bit versus where maybe you were 10 years ago?

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