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Key Tools for a Tough Retirement Environment

Christine Benz

Christine Benz: I'm Christine Benz for Morningstar.

Retirees face a very challenging environment, including low yields and very high stock market volatility.

Joining me to share some tips on how retirees and pre-retirees can navigate is Sue Stevens. She is CEO of Stevens Wealth Management.

Sue, thank you so much for being here.

Sue Stevens: It’s my pleasure.

Benz: So Sue I outlined some of the big headwinds that retirees are facing right now. You have got yields very low and a lot of market volatility, also the threat of rising interest rates.

So, one thing I'd like to start with is, the historical prescription for a retiree or pre-retiree portfolio is a lot of fixed income. What's your take on how people should approach that issue? Is fixed income still essential to retiree portfolios, and what should the complexion of it look like?

Stevens: Great question. I think fixed income still needs to be a major component of most people's retirement portfolios. I think things have changed a bit in that rates are incredibly low right now, but the purpose of fixed income hasn’t changed, which is stability, some sort of income, something that will keep the portfolio steady and allow people to sleep at night.

So, my approach right now might be to more broadly diversify the types of fixed income that clients are in, maybe pull down what's in Treasuries, push up what’s in corporates, maybe some high-yield, maybe some mortgage-backed to try to get a little bit higher yield, not much, 0.5%, maybe 1%, from what we might've done in the past. But I think that helps create more of a constant return that people are looking for.

Benz: So your thought on pulling down Treasuries at this juncture is mainly a concern about their vulnerability in the face of rising interest rates, or what are you responding to there?

Stevens:  I think Treasuries are an interesting topic. There are kind of two parts to it that I would say: one is the vulnerability that we have massive challenges ahead of us with debt and health-care costs and those types of things that could again pull down the rating of our government debt. So, I think you have to be a little bit thoughtful about, how is that going to work going forward.

But the other part of Treasuries I think is that, they are safe haven. So, I don’t think you can discount them either. I think when we see things happen ... I've heard some people say America's become the new Switzerland. So, people are pushing in to our bonds, in particular, when things go wrong in other places in the world. So, to me, you still want some presence in Treasuries, but maybe just not as much as we had before.

Benz: That was certainly the case in 2008. It was really the only asset class that provided any salvation for anyone. If they had Treasuries, they at least had some of their portfolio that performed reasonably well.

I'd like to follow up with you, Sue, on the role of foreign bonds in a portfolio. That’s been a big buzz at this conference. People have been talking about developing-markets bonds in particular as maybe having better characteristics right now than say developed-markets debt.

What's your take on that question and how much, if any, of your client portfolios are invested in foreign and developing-markets debt?

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Stevens: I think the answer is, it's an increasing percentage. I think it is important. I think we have to be careful about that home bias that we all come with, and open our minds to the fact that places are growing faster than we are, countries around the world are growing faster than we are.

So, I'm typically targeting between 5% and 10% in foreign debt. That can be a combination of some of the larger countries, but I think there's an education, too, in recognizing the emerging countries have emerged--you are calling it "developing," I think that makes perfect sense, and I have more and more exposure to those areas.

But with it would come an education that they still can be volatile and that we need to understand it's a little bit different animal. So, the chance for growth is there, but also there's a chance for loss, and we need to factor that in, too.

Benz: One other important consideration for anyone approaching retirement or in retirement is this issue of withdrawal rates or distribution rates, and I think when people look at some of the prognostications about what people are forecasting for various asset classes, it's not very encouraging.

How should retirees think about setting their withdrawal rates so that their portfolios can sustain them over whatever period they need them to last?

Stevens: I think there are a couple of ways of looking at this. I think one thing I would want to say is, even though the mood is kind of pessimistic at the moment, we are seeing more encouraging signs out there, and there will come a day when markets turn around, and we start to see better growth.

So, what you're really doing is you're managing in the shorter period for low interest rates, for low rates of return, and I think you need to adjust your expectations to more of a 4% or 5% return on a balanced portfolio, and down the road hopefully that'll get higher.

But as far as withdrawal rates go, I think that the studies that are out there are helpful. I think there are some limitations with them in that I see a lot of clients wanting more in fixed income now, and they don't really fit the underlying assumptions that are in those studies.

So to me, that would just, common sense, mean that maybe instead of a 4% rate, you're looking at a 3% rate. I would probably go a little more on the conservative side to factor in things like taxes and other irregular cash flows that may happen over time, and to just give a little bit more of a cushion. If we get back to more of the strong wind behind our back days, then maybe those rates can go up, and they do go up as someone ages.

Benz: So you would recommend, to some extent, staying flexible to what's going on in the market. Were you pulling in withdrawals during the bear market? Were you encouraging people to take less?

Stevens: Again, great question, and I think I probably had a discussion about budgeting with almost every client that we had. We went through the exercise of rerunning retirement projections to look at things again, and in general, everything was still on track, but people I think are common sense, and they know that when things are tough, they are going to probably tighten the belt a little bit. It doesn't have to be extreme. There are studies out there that show maybe you want to pull it back 25%. I'm not sure it needs to be quite that much, but I think a 10% adjustment most people can weather fairly well, especially if it's four or five years that they have to do something a little bit different with their portfolio.

So, I think everyone took that discussion well. I think a lot of people welcomed that kind of proactive advice, and portfolios have recovered for the most part at this point, but there is going to be something that comes up next, and I think you do have to stay flexible.

Benz: It maybe is psychologically gratifying to some extent--you feel like you're doing something; you're doing your part...

Stevens: That's right.

Benz: ... Even while you have no control over what your investments are doing, if you're pulling in your belt a little, you can do your part.

Stevens: Right.

Benz: So, we have talked about withdrawal rates and approaching fixed income, but I'd think to discuss levers that retirees have if they are looking at what they've managed to save and fearing that they may come up short.

Let's talk about that Social Security lever, which I think there has been so much research recently about what an impactful addition to retirees' plans that can be. What can retirees do to maximize their benefit from the program over their lifetimes?

Stevens: This is definitely something that I think is becoming more conscious for more people--even my mother in the car the other day said, "Why don't you write something on Social Security?"

So, I think what's happening is, people are recognizing that there are more alternatives than maybe they knew about, and there is more software out there that can help people look at those decisions. We've recently started using one of them that's out there, and what we found is, especially for a spouse, they may be able to take benefits at their full retirement age based on their husband's or wife's history and delay their own benefits until 70. And that delaying until 70 seems to be really important, whether it's a single person or a married couple. They can increase the amount that they get from Social Security by up to 80%, which is huge. So, even if you are taking Social Security, potentially you can stop and reset it again later, depending on the circumstances, but I think it's worth really taking a look at that.

The other caveat, I'd say, with Social Security is just that, it's likely that going forward, for some people, they won't be able to rely on it as much, and I think that needs to be factored in, too, and that maybe as you do retirement projections, you pull back a little bit on some people that are in the highest income brackets as far as what they may expect from that. And I think Simpson-Bowles gets at, maybe there will be more means-testing, maybe the age will get raised. There will be things that have to happen to make sure that we're solvent.

Benz: So, that was a question I wanted to ask you. If I am someone in my 40s, if I come into your office and I'm asking you about whether we factor Social Security into the strategy or not, you would say maybe give it a haircut based on the fact that there might be some adjustments to the benefits as we go on.

Stevens: Yes. I think that's a fair statement, especially for somebody in their 40s. I wouldn't say it's not going to be there. I'm just going to say, I think, let's take 20% off of it right now, and see what that does. And really I think the message that will come through with that is, you may need to save more, but that's the message that should come through in most cases, anyway.

Benz: Especially when you're in your 40s, and you have time to maybe achieve something there.

So, for folks who are in there 60s or maybe already taking benefits, do you assume status quo, that you'll be able to rely on benefits as currently configured?

Stevens: I think for the most part that would be true. I think the people that may lose part of their benefits are the ones in highest asset brackets, and those are probably the people that could afford to lose a portion of their benefits. I don't think they'll lose them entirely. I think they are means-tested today in that if you're in a higher bracket, you're going to pay more income tax on it; that's a way of means-testing. So, I think there will be more of that, and for the younger people, I think something will be there, too, but it may be a completely different way of saving for the retirement day than we had.

Benz: OK. Sue it's always great to hear your insights. Thank you so much for being here.

Stevens: Thank you.

Benz: Thanks for watching. I'm Christine Benz for Morningstar.