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The Top Headwinds Facing Retirees

Jason Stipp

Jason Stipp: I am Jason Stipp for Morningstar.

It's Retirement Portfolio Week on, and we wanted to kick off our coverage by talking about some of the headwinds that retirees are facing today.

Here with me to discuss is Morningstar's Christine Benz, director of personal finance.

Thanks for joining me, Christine.

Christine Benz: Jason, great to be here.

Stipp: So, I guess the bad news is there are a lot of headwinds that retirees are facing today. The good news is, this week we hope to get some answers, some solutions, and some tips to help investors manage through some of these.

Christine, if you had to pick out the top headwind facing retired investors right now, what would that first issue be?

Benz: Well, certainly based on comments on articles and also e-mails I have been receiving from users directly, it's rising rates. People are very worried about how their fixed-income portfolios will behave against the headwind of rising interest rates. So we're really hoping to shed some light on survival strategies in what could be a rising rate environment.

Mark Balasa, he is financial planner here in the Chicago area, will be joining us on Monday. He is going to be talking, I am sure, about some of the strategies that he is using in his client portfolios. He e-mailed me the other day and said he has never received so many questions about bonds from his clients before.

One thing we'll be interested to hear is whether rising rate worries at least in the very near term are somewhat overblown? Miriam Sjoblom, who will also be sitting down with us to discuss fixed income, will be talking about what she is hearing from some of the fund managers that she and the team interview. It will be interesting to get that institutional investor perspective on whether rising rate worries could be really overblown at this point.

Stipp: So Miriam and Mark will be joining us for two webcasts that we'll be doing; one will be live on Monday, one that will be airing on Friday.

So speaking of fixed income, I know another area of concern is the muni market, and there is a lot of worry about that financial strength of municipalities. What do you hope to learn on that front?

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Benz: Well, that's an issue that our users are wrestling with directly as well. A lot of them are very concerned. And there was a big sell-off in muni bonds in the last half of 2010, and there was a lot of concern that maybe this was drive by fears about municipalities. Of course, their financial strength is not what it could be, but there have been differing opinions on what really drove the muni market down and what could drive it down in the future.

Miriam has said that simply concerns over rising rates as well as an oversupply within the muni market possibly were bigger factors, not really municipalities' poor financial conditions. So it will be interesting to hear what specifically is driving the muni market down and what could weigh on it in the future.

Stipp: Certainly, very interesting to hear about what technical factors might have been at work there as well.

Benz: Right. Exactly.

Stipp: Another things that's related to rising rates, and that we've actually seen heat up a little bit, is inflation, and I know that this is a big concern for retired investors, especially who have more fixed income or fixed-income sources. What are you hoping to learn on that front?

Benz: You're right, Jason. So retirees have fixed incomes and some of the costs that have been going up recently are ones that hit retirees particularly hard. So you've got food costs, and you've also got energy costs, both to heat their homes and also to fuel their cars. Those are some of the big price increases that we've seen recently.

I am always looking for best ideas for inflation-proofing portfolios, and one person in one of our webcasts, the first webcast, Jeff Ptak, who runs some client portfolios here at Morningstar, will be talking about how to inflation-protect portfolios. He and the team have looked at various asset classes. One category they've homed in on, among others, that has good inflationary characteristics is the bank loan group. So I hope he'll discuss which are the good investments in that category and also how much is the right amount to hold there, because that's not a category where I would think most investors would want to go overboard.

Stipp: So coupled with the concerns over rising rates and inflation is another concern that makes--I hate to use the term, "perfect storm"--but really a dilemma for investors, and that's [the fact that] currently, the yields that retired investors can get are low. So although rates may go up in the future, they can't really capture that right now. What solutions might we hear about that this week?

Benz: Well, I'm hoping we can hear some creative solutions because really there aren't many safe ways to earn a decent yield these days. So I know Josh Peters, who is our dividend strategist, is always keenly attuned to finding companies with healthy dividend yields that have a good margin of safety. So I'm hoping to hear some ideas in that vein, and also on the bond side as well, some ways you can maybe tiptoe into a slightly higher yield without taking on extra risk.

Stipp: Certainly the low-yield environment increases the importance of making sure that you can squeeze out some efficiencies wherever you can: One of those areas is in Social Security. I know that one of our guests might have some tips there.

Benz: Right. That's Christine Fahlund from T. Rowe Price. She's going to be in the webcast that we're doing on Monday. And she and her team at T. Rowe, they focus on financial planning issues and really try to come up with concrete strategies for retirees. So they've done a lot of work on Social Security maximization. How to--not game the system--but really how to wring out the best possible level of income you can from Social Security over your lifespan and over your spouse's lifespan, so I think she'll be sharing some interesting tricks that you can think about using there.

Stipp: Sounds like, hopefully, some very practical advice,

So if certain areas of the market look a little bit cloudy, especially fixed income right now, investors might want to be looking to equities. However, there is not a whole lot of great news on a broad spectrum of equities right now because the market is looking pretty fairly valued overall. Where might we learn how to place our money in equities to get a little bit of safe, but maybe extra return?

Benz: I hope to get a lot of ideas from a lot of different places. Scott Burns, certainly in the ETF space, we'll be talking to him about some of his best ideas, and I'm sure some of them will include equity ideas. The nice thing about ETFs is that costs are nice and low, so if you are looking at any sort of dividend-yielding product, an ETF is a really nice way to play it because the expenses are low, your take-home yield is that much higher.

Josh Peters, obviously, also is another good person to talk to us about safe sources of dividend yield.

Stipp: So checking in with some of our strategists. They might be able to uncover some pockets of value for us. Certainly it seems like a lot of the easy money, so to speak, has been made in the stock market--time to be a little more selective perhaps.

The last headwind, the last issue that we're going to be discussing this week in depth is what's known as longevity risk, and this is basically the fact that retirement is a long-term prospect, and it's something that you need to plan for, not over a period of a couple of years, but over a period of maybe 25 or more years.

Benz: Right, and that's getting increasingly stretched out. It's good news in so many ways that we're all living longer and healthier lives, but it does increase the period of time that we need to plan for. And one thing, we'll be discussing in several different ways is the role of annuities in portfolios.

There has been a lot of research, including some done by our colleagues here at Ibbotson, talking about how annuities can be quite additive to retiree portfolios, but only certain types of annuities. Obviously, this is a category where there are lots of very pricey options, so you need to be careful.

And one question I would like to get to the bottom of is, with the current interest rate environment, if you lock in an annuity right now, you're settling for what is a very low payout. So how do you hedge against that possibility that you would buy an annuity at what could turn out to be precisely the wrong time? So I'm thinking Christine Fahlund from T. Rowe Price, as well as Mark Balasa will both share some experiences and share some research that they've done in that area.

Stipp: Well, Christine, it sounds like a very timely and interesting roster of topics. I really look forward to our coverage this week. Thanks for joining me today.

Benz: Thank you, Jason.

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