Jason Stipp: I'm Jason Stipp for Morningstar. If you're a retired investor and you want to slim down the number of holdings in your portfolio, there are a few categories of investments you can probably take a pass on. Morningstar's Christine Benz, our director of personal finance, is here to explain more.
Thanks for joining me, Christine.
Christine Benz: Jason, it's great to be here.
Stipp: So, you say if you're a retired investor, you want to keep it simple. There are a few types of funds that you can say, "Thanks, but no thanks." Before we get to those, though, what are the advantages of not having a lot of excess baggage in a retirement portfolio?
Benz: There are a few. One of the key ones is that as you become retired you may not want to spend that much time on day-to-day portfolio oversight or, certainly in your later years, you may encounter some issue that will keep you away from your portfolio for a period of time--a disability, for example.
The other thing--and this is a big topic--I often hear from our retired users who are active hands-on investors themselves, but they say their spouses aren't highly engaged investors. So, as they are getting into retirement, they start thinking about, "How can I build a portfolio that my spouse could easily oversee if he or she needed to do that?" So, that's another key advantage to reducing the number of holdings.
And finally, I would say that if you are able to get rid of some of these more narrowly focused holdings, you're probably able to reduce the angst associated with your portfolio. So, if you don't have these holdings that have extreme highs and lows, you will just have less hand-wringing over that portfolio. You will maybe hold some of those investment types within more broadly diversified funds, but you're not holding them as standalone offerings. They'll just tend to provide you a little more peace of mind.
Stipp: You'll have a smoother ride, and you won't see all those bumps in those really niche type of holdings. So, what we're talking about here are in-retirement portfolios, suggestions for folks who are in the retirement years, not necessarily folks before retirement.
Benz: That's exactly right. These are people who are already in retirement, getting ready to spend their portfolios.
Stipp: The first investment type that you think investors should really think hard about before they get into is foreign-currency-denominated bonds. A lot of investors have looked beyond the typical bond fund as yields have been so low. But you say that you should really think twice if you're a retired investor before going into these foreign-currency-denominated bonds.
Benz: The key reason is volatility, Jason. Our colleagues here at Ibbotson Associates have looked hard at this question, and they are very much for that foreign-currency diversification for people who are in accumulation mode. But as people get closer to retirement, they think that they should back off the foreign-currency exposure. The reason is that you hold bonds to act differently than your equity portfolio--when, in fact, foreign-currency-denominated bonds tend to have a lot more volatility than, say, core U.S.-dollar-denominated bonds.
So, you want to be careful before adding foreign-currency-denominated bonds. I looked at PIMCO's hedged Foreign Bond Fund versus its unhedged product. The volatility on the hedged version is substantially lower. It has had a standard deviation of 4 over the past decade versus 9 for the unhedged version. So, that's a huge difference in volatility.
I think you might reasonably own some foreign-currency-denominated bonds in a broadly diversified fund. Maybe you might hold Loomis Sayles Bond or something like that. But I think that dedicated foreign-currency-denominated bond fund probably isn't a necessity for most retiree portfolios.Read Full Transcript
Stipp: The second fund that you might want to think twice before owning in retirement is a dedicated emerging-markets fund. You might have emerging-markets exposure, but you're saying maybe not as just one single fund?
Benz: That's right. Here again, I think it's a category that tends to be kind of duplicative. These days, most broadly diversified foreign-stock funds do have a healthy share of their portfolios in emerging markets--anywhere from 10% to 20%. So, take a look at what you have already before layering on an additional emerging-markets fund. Here again, I think it's a volatility story. When you look at the standard deviation, 4 in an emerging-markets fund relative to a foreign-stock fund. You see at least somewhat higher volatility, not quite as high as we saw with the hedged- versus unhedged-bond portfolios. But you still do see a volatility discrepancy. So, I think that that's another issue.
And then, finally, cost is an issue. If you go out and buy a dedicated EM fund, typically you're going to pay a higher price tag for it. Some of the index products are pretty reasonably priced; but certainly if you're looking at any sort of actively managed product, it will generally cost more than a broadly diversified foreign-stock fund.
Stipp: The third category is one I'm sure investors have heard a lot about but maybe don't really fully understand, and that's alternatives. Why might you want to think twice before you jump into alternatives?
Benz: Well, first of all, I would say that it's a very broad basket, and we see a lot of different strategies falling under the alternatives heading. You have bear-market funds, you have funds that use leverage to amp up their returns, and then you also have a category of funds that seeks to provide some equity exposure but with a little bit less of an edge than you might get by holding a pure equity portfolio.
We've seen a lot of assets flowing into alternatives over the past few years, I think, in part because people are still a little bit stressed out about what they experienced during the bear market. But I think there are a couple of reasons that retirees don't need some sort of dedicated alternative fund.
The first one is that if you do have core equity and core fixed-income exposure, the alternative fund may not give you a lot of diversification. If you're looking at categories like long/short equity, for example--and that's one of the categories where we've seen a lot of the inflows--what you tend to see is a performance pattern that falls somewhere between the stock and bond markets but much higher costs.
It's not unusual to see funds with upwards of 2% expense ratios. So, you're looking at returns that fall in the neighborhood of maybe 8% over the past five years but 2% expense ratios. That's a really high percentage of your return that you're ceding to expenses. So, I just think that the value proposition--certainly when you look across the whole category of alternatives--I think the value proposition just isn't there for retirees.
Stipp: Christine, you've shown time and again that a simple strategy can really be effective for retired investors. I think this is just more a proof of that. Thanks for joining me.
Benz: Thank you, Jason.
Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.