Retiring in a Down Market? Consider These Strategies

Key Takeaways

• Look at discretionary versus nondiscretionary spending to figure out where there is flexibility.
• If you are thinking about deferring Social Security and that you may need to spend more from your portfolio in the period leading up to that, that may be OK. Run the numbers and understand the trade-offs.
• Make sure you have a globally diversified low-cost portfolio. Determine what your goals are and then set your asset allocation.

Christine Benz: Hi, I'm Christine Benz from Morningstar. For new retirees, 2022 has been a challenging year in that we've had falling stock and bond prices. Joining me to discuss some strategies that new retirees should bear in mind in this environment is Maria Bruno. She is head of U.S. wealth planning research for Vanguard.

Maria, thank you so much for being here.

Maria Bruno: Hi, Christine. Thanks for having me.

The Benefits of Reducing Spending

Benz: Great to have you here. So, this year has been incredibly challenging for retirees. I think many of them have heard of the virtue of perhaps drawing in spending, reducing spending during this period. Can you talk about the benefits of reducing spending in periods in which your portfolio has declined and how people should think about that?

Bruno: We talk a lot about that with investing in terms of focusing on the things you can control. Spending is certainly one of those when you think about the discipline part of it. But it can be hard for retirees when you think about what they're spending on.

I think the first thing would be to look at discretionary versus nondiscretionary spending. Are there any [areas] you can flex on, those nice-to-have expenses? Those would be the first place to look at in terms of flexibility. I think this is a year where that flexibility is really being stress-tested. We talk about rules of thumb a lot in terms of spending rates, and they are just that. So, for many individuals, when the markets are up, we always advise them to really look at their spending and to be thoughtful and to reinvest surpluses to give them a buffer in these types of market environments when we're experiencing volatility. It can give us a little bit of a buffer, kind of a little bit of a floor to give us a little bit more ability to flex in those situations. So, think about that in terms of especially going forward to have flexibility when you can cut back because then that will give you even more flexibility down the road in those situations where the markets are more uncertain, and it becomes more critical to think about spending and focus on meeting those nondiscretionary type, must-have-type expenses.

How Does Inflation Play a Part?

Benz: I did want to touch on inflation because many people have gotten the message about, yes, it's important to try to reduce my spending if my portfolio balance is down. The question is, with inflation, especially inflation in some of those nondiscretionary areas--food and gas prices, for example--people may literally have a difficult time reducing spending. How should people think about that?

Bruno: This is a very difficult one. Because there are certain things like healthcare, and you can just see it at the grocery store, or utilities and things like that, where it's becoming very apparent in terms of the impacts of inflation. For many individuals, some of this is already planned for when they do financial planning, and they think about what their spending can be and what their portfolio sources and nonportfolio sources of income are. First, make sure you understand how much you're spending and where that money is going, and then also think about your income sources. So, one example, maybe we'll talk a little bit more about this, is Social Security. Social Security is indexed to inflation. So, those are things that as a retiree you can think about, too, in terms of what the income sources are. Your portfolio income--interest rates being higher for bond investors, that's not necessarily a bad thing in terms of income. So, it's putting the pieces together and not just focusing on the expenses, but also looking at, OK, what are the income sources and how are they allocated to those expenses.

Should You Delay Filing for Social Security?

Benz: You referenced Social Security, Maria, and I did want to dig into that, because we had been seeing this trend for the past couple of years at least where it seemed like people were getting the message about the benefits of delaying filing. A question I think that probably is running across many pre-retiree or retirees' minds is if their portfolio balances are down, should they actually accelerate that claiming decision, maybe file a little earlier than they had expected to? How should they think about those two things: depressed portfolio balance versus that Social Security filing decision?

Bruno: That is a good one. So, when you look at Social Security and the options around Social Security--and again, these are for situations for individuals who haven't yet claimed and really thinking through what the value of deferral is. As you've mentioned, I think many retirees are seeing the value of that. Meaning, for every year after full retirement age that you defer there is an 8% increase in the benefit, and that's also inflation adjusted. So, there's a very rich benefit to deferring. So, that's terrific. The question then is, well, I need the income, how do I meet my expenses? And then, that would be other sources of income and potentially portfolio-based withdrawals, and that may not necessarily be a bad thing.

You want to look at, well, what are your investment flows, first and foremost. So, spending from the portfolio isn't always spending "principal." There are income distributions, and when we have experiences with high interest rates, that may be more interest income, for instance, for investors that have both stocks and bonds. So, you want to look at the inflows, but then also what you're spending from the portfolio. The reality of it is, if you are thinking about deferring Social Security and that you may need to spend more from your portfolio during this period leading up to that, that may be OK because then you may be getting the benefits later. It's really good to run the numbers on some of this to understand the trade-offs.

Key Considerations When Setting Your Asset Allocation

Benz: Let's talk about asset allocation, which we've sort of touched on already, but I think that retirees may be feeling really nervous in that they've had the two key portions of their portfolio fall at the same time. So, how should people, especially new retirees, approach asset allocation in this environment? I'm sure many of them are pretty attractive to cash just holding its ground in this environment. But can you talk through some of the key considerations that people should bear in mind when setting that asset allocation?

Bruno: I think that's more important now than ever before in terms of making sure you have a globally diversified low-cost portfolio. And how you achieve that is, first, determining what your goals are and then asset allocate to that. So, for many retirees, you want to make sure you have a globally diversified portfolio, meaning both U.S. and non-U.S. stocks and bonds, because we are a global economy, and the markets will perform differently. Cash can play a role, but think about it more in terms of spending, whether it's near-term spending--it might be OK to have a little bit of a buffer up to a year, 18 months in cash. But anything more than that, you really need to understand that there's an opportunity cost to not being invested in the market, and that will manifest itself over time because the portfolio is not able to keep up with inflation. So, cash plays a role, but think more around principal preservation for short-term goals. Beyond that, you want to make sure you have a well-diversified portfolio and rebalance to that. So, sometimes a starting point could be to look at a target-date fund. So, many financial institutions, there's a whole array of balanced funds or target-date funds, and that can be a good proxy for someone who is heading into retirement. But you really do want to personalize that based upon what your specific goals are and your risk tolerance.

Benz: Maria, super helpful rundown of some strategies that new retirees should be considering. Thank you so much for being here today.

Bruno: Thank you as always, Christine. Thanks for having me.

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

Watch “Good Reasons to Overhaul Your Portfolio” by Christine Benz.