3 Key Gauges on Your Retirement Dashboard

Note: This video is part of Morningstar's January 2016 5-Step Retirement-Portfolio Assessment Week special report.

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. The combination of a volatile market environment and also the proliferation of financial information can make it challenging for many retirees to know where they stand. I'm here today with Christine Benz--she is our director of personal finance--for three tips on keeping tabs on your retirement portfolio.

Christine, thanks for joining me.

Christine Benz: Jeremy, great to be here.

Glaser: So, if you are a retiree and you're trying to gauge how your portfolio is doing, what vital signs should you be looking for? What's the top one there?

Benz: The top one is your withdrawal rate or your spending rate. There are a few different ways to think about this. The 4% rule that a lot of people are familiar with assumes that retirees want more or less static dollar amount throughout their retirement years, so it assumes that you take 4% of your initial balance in year one of retirement and then you gradually inflation-adjust that dollar amount as the years go by.

So, if you are using that measure, it's helpful to keep tabs on whether you are staying within your expected parameters. I think it can make sense for a lot of retirees to think about looking at their spending rate over maybe a three-year period because it's very difficult to make a prediction that's right on the button in terms of your anticipated spending. You might look for some variation from year to year; but as long as that three-year number averages out to be the right dollar amount, you should be OK.

Some retirees simply say that they would like to take a fixed percentage from their portfolio--maybe 3% or 4% per year. That means that their dollar withdrawals will actually fluctuate around a bit from year to year; but some retirees say they are comfortable with that. And certainly when it comes to portfolio sustainability, if you are just spending a certain percentage of your portfolio, there is at least some guarantee that you will never run out of money.

So, there are a few ways to do it, but definitely keep your eyes on that spending rate. Make sure that over, say, a three- or five-year period your spending rate is in line with your expectations and certainly not running into the double digits.

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Glaser: After investors look at that withdrawal rate, what's next? Should they be looking at what their cash position looks like?

Benz: I think that's a great next step. As you know, I'm a big believer in what's called the bucket approach to retirement-portfolio planning. The basic idea there is that you are setting aside enough liquid reserves to tide you over if the long-term portion of your portfolio becomes volatile. A lot of research in the realm of retirement planning shows that what's called "bad sequencing" can really impact a portfolio negatively. So, if you encounter a lousy market environment early in your retirement years and you are actively drawing from those investments while they are depressed, that's a way to lock in those losses, and it can really reduce that portfolio's overall level of sustainability. So, that's one reason why this bucket approach can be effective.

The basic idea is that you are setting aside six months' to two years' worth of living expenses above and beyond what's covered by any pensions or Social Security--or other certain sources of income that you might have. You are setting aside that money; you are parking it in cash. You are not taking any risk with that portion of your portfolio. It's there to supply your living expenses on an ongoing basis. That way, if your long-term portfolio does encounter a rough time, you will not have to invade those securities when they are at a low ebb.

Glaser:  If you have other income sources--say from Social Security or a pension--how would that impact that decision?

Benz: That's a really important point because I think some people hear about that two years' worth of living expenses and think, "Gosh, that's a lot of money." So, at the front end, you want to think about how much of your income needs are being covered by certain sources of income--Social Security and pensions, in particular. You would want to subtract them from your income needs in a given year. The amount that's left over is the amount that your portfolio is going to need to replace. That's the amount that you would want to set aside in cash--six months' worth of living expenses or two years' worth of living expenses above and beyond what is being supplied by your steady sources of income.

Glaser: Even after retirement, many investors' portfolios are going to have riskier portions--they are going to have portions set aside for later in retirement. How do you keep tabs on that and make sure you are not taking on too much risk? What are the right signs to look for?

Benz: One thing that I think should be on every investor's dashboard, regardless of life stage, is simply a blended benchmark that mirrors the investor's own portfolio in terms of its asset allocation.

I think a great first step for investors of all ages is to take an X-Ray of their portfolio. You can use our Instant X-Ray tool or you take a look at your investments by saving your portfolio in Portfolio Manager. Take an X-Ray view, check the portfolio's current asset allocations, and then set up a mirror portfolio composed of very cheap, very simple index funds and exchange-traded funds.

I think it's important not to slice things too thinly. So, even if your portfolio has perhaps a high-yield bond fund, just use total-market indexes--use a total U.S., total international, and total bond-market index tracker as well as a cash position, if you have cash holdings in your portfolio. Set up that blended benchmark; use it to gauge the decisions that you've made in terms of managing your portfolio.

So, if over a period of time--a good, long period of time like five years or more--you really haven't beaten that blended benchmark, this could be your cue to maybe switch to a portfolio that is more hands-off, where you are using some of those very vanilla low-cost index funds to replace some of those more-active choices.

Another thing I like about the blended benchmark is that I think it might be a cue to some investors that they could get away with a more-simplified portfolio mix than what they have. And in my view, this is particularly important for retirees, especially later retirees who perhaps they don't have the time or inclination or perhaps even the ability to monitor a portfolio that has a lot of moving parts. Simpler can be better, especially later in retirement.

Glaser: Christine, as always, thanks for your thoughts today.

Benz: Jeremy, great to be here.

Glaser: For Morningstar, I'm Jeremy Glaser. Thanks for watching.