3 Things Retirees Should Watch in 2022

Susan Dziubinski: I'm Susan Dziubinski with Morningstar. It's a new year and Morningstar's Christine Benz thinks that there are three big issues retirees should have on their radars this year. She is here to discuss them.

Hi, Christine. Nice to see you.

Christine Benz: Hi, Susan. Great to see you.

Dziubinski: One theme that was sort of top of mind for most investors in 2021 was inflation. And you say this is something that retirees should probably keep on their radars again in 2022, right?

Benz: Absolutely. We often hear about the spending part of inflation, the effect on our purchasing power. But I do think it's important to look at this from both sides of the ledger. Certainly, you want to look at how your spending has changed, how inflation has affected your spending and potential implications for how much you're withdrawing from your portfolio. So, you can't not think about all of that. But I think you also want to think about how well protected you are from rising prices. A perfect scenario would be someone who has all of their income that's coming in the form of a pension, and maybe they're a government worker so it's a nice inflation-adjusted pension. Increasingly rare, but nonetheless, that is a person who is almost perfectly protected from inflationary forces, because they're getting a little bit of nudge up in their income. At the opposite extreme would be someone who has all of their investments parked in very safe securities, in CDs, for example. That person is seeing his or her purchasing power be gobbled up by inflation. So, that person would need to take pains to protect against inflation. Most retirees fall somewhere in the middle where they're deriving some of their income from inflation-protected income sources like Social Security, but they're also withdrawing from their portfolios. And I think that's the part where you can think about making sure that you are insulated in the portion of your portfolio that you're pulling out to spend.

Dziubinski: Let's say a retiree does his or her due diligence and really examines the portfolio and says, "Yeah, you know what, I might benefit from a little bit more inflation protection." What sort of tools should they be looking at for that?

Benz: Well, certainly, within the safe portion of the portfolio, I would look to Treasury Inflation-Protected Securities, I Bonds, which are pretty much a direct hedge against inflation, against unexpected inflation, I should say. So, anyone who has fixed-income securities in their portfolio, I think it makes sense to include some Treasury Inflation-Protected Securities or I Bonds as a component of that fixed-income portfolio.

Stocks tend to outearn inflation over time. While they are no direct inflation hedge, they nonetheless over long periods of time do help protect that portion of our portfolios from inflation. Dividend-growth stocks, I think, are arguably particularly attractive in such an environment in that companies that fit this description are growing their dividends, which help you keep pace with inflation over time. But stocks tend to deliver nice long-term protection against inflation. So, I would say, most retirees, if they're looking at their portfolios today, should check for those two key ingredients.

And then, there are other more sort of specialized ingredients they might look at. Commodities would be one category, although my bias is that they are too volatile for most investments. Real estate securities would be another category to consider.

Dziubinski: Now, another topic that you suggest retirees keep an eye on in 2022 are interest rates. Talk about that.

Benz: Right. The Federal Reserve has signaled that it plans to pull back on its bond-buying program. We've also already seen some reverberations in the bond market in anticipation of that. But I would not be at all surprised to see some interest-rate-related volatility in 2022. I think retirees with bonds in their portfolio or even with interest-rate-sensitive stocks like utilities, for example, might be prepared for a little bit of volatility in that portion of the portfolio. And I think it's a reminder to make sure that within your fixed-income portfolio match your time horizon to the types of bonds that you're investing in. Long-term bonds tend to be the most rate sensitive. If you have a very short-term time horizon in terms of your spending from your bond portfolio, you probably want to shorten up and be in a short-term bond fund or even an ultra-short-term bond fund. So, think about that as well.

Dziubinski: So, don't necessarily go and dump bonds. Just perhaps reconsider how your suballocations are looking, right?

Benz: Exactly. And I'm so glad you asked that question, Susan, because I think there's been hand-wringing about this for a while that inevitably we'll see this increase in interest rates and that will make bond funds bad. And I think the thing that people want to remember is that if you hold bonds in your portfolio and bond funds, you're looking to return of principal, not return on principal. So, yields are really low today. We do have a little bit of worries over interest-rate changes. But bonds do tend to be good ballast in periods of equity market volatility, and I think bonds will continue to fulfill that role. So, I absolutely wouldn't throw them overboard.

Dziubinski: And lastly, Christine, you say that it's important that retirees, but especially new retirees, pay very close attention to their spending and their expected spending in 2022. Let's unpack that a little bit.

Benz: Right. It's a good news bad news story. So, we'll start with the good news. The good news is that portfolio balances are enlarged. The bad news is that given how well the equity market has performed and how elevated equity valuations are today, given how low bond yields are, given the emerging threat of inflation, it suggests that people, if they're taking a fixed real withdrawal from their portfolio, so if they're using a 4% style guideline, that they should set that initial withdrawal pretty low in case a bad market environment materializes early on in their retirement.

Our recent research pointed to a starting withdrawal of roughly 3.3% for people with balanced portfolios in a 30-year time horizon. But there are some nudges that you can make around the margin of your plan. If you're a person with a shorter time horizon, so you're someone who is retiring fairly late in life, you could probably take a larger starting withdrawal because your in-retirement time horizon is reduced somewhat. If you're anticipating that your spending in retirement will trend down over your retirement, and the data certainly suggests that most retirees do tend to experience a downward slope in their spending, well then, you too could take a higher withdrawal to start. And then, there are a variety of flexible strategies that people could explore. I would urge people to take a look at them. Some of them aren't super invasive and uncomfortable and do tend to lift lifetime withdrawals. So, I would start there. And if someone is just embarking on retirement, I do think that planning to be conservative, at least initially, seems like a good plan.

Dziubinski: Well, Christine, thank you so much for your time today and giving retirees some ideas of the things to look out for in 2022. We appreciate it.

Benz: Thank you so much, Susan.

Dziubinski: I'm Susan Dziubinski. Thanks for tuning in.