4 Retiree To-Dos in a Turbulent Market

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser.

Retirees who are actively withdrawing from their portfolio are often the most nervous around market volatility, and understandably so. They don't have the luxury of saving more or working longer in order to make up some of those losses.

I'm joined today by Christine Benz, our director of personal finance, with four to-dos for retirees in times of market volatility.

Christine, thanks for joining me today.

Christine Benz: Jeremy, it's great to be here.

Glaser: Your first to-do is to check your liquid reserves. Could you talk about why that's important for retirees?

Benz: It's really important from a psychological standpoint. That's one of the reasons I'm such a big proponent of the so-called bucket approach to retirement portfolio allocation. The basic idea of the bucket strategy is that you set aside one to two years' worth of living expenses in true cash instruments. Then your long-term portfolio is going to do what it's going to do. It may be volatile at various points in time, as has been the case with equity markets over the past month, but you know that you have your money for living expenses set aside. I think this is a good strategy regardless of the approach you're taking to extract money from your portfolio. Setting aside that baseline in true cash reserves makes a lot of sense.

Of course, you want to be careful. Cash yields are very, very low right now, so you want to be careful not to have too much in cash. I think one to two years' worth of living expenses is about right.

Glaser: What if you haven't set up this bucket portfolio yet, and you don't have these cash reserves? Is it too late? Would you have to sell into this down market in order to raise that cash?

Benz: That's a really good question. People may be looking at this bucket strategy and saying, yes, I see the appeal … volatile markets accentuate the appeal of the bucket approach. But is it too late? I don't think so. The reason being that if you have a fair amount of equities in your portfolio, you've had pretty nice gains on that piece of your portfolio over the past six-plus years. It's not too late to take some of those profits and steer some of that money into cash, perhaps steer some of that money into high-quality bonds, and get yourself into a better diversified portfolio mix.

Glaser: Is now the time to look at your overall asset allocation?

Benz: Definitely. This is another thing I would put on retirees' to-do list. Use Morningstar's X-ray tool; see what it looks like in terms of how your portfolio is allocated across cash and bonds and stocks. The reason it's so important to be well-diversified across asset classes is that asset allocation diversification is going to be the main determinant of how your portfolio behaves.

We've seen over the past month, the sell-off in equities has been pretty indiscriminant. It doesn't matter if you've been in large or small caps, whether you've been in value or growth stocks, or really how you've been diversified internationally. What's mattered has been whether you have high-quality bonds in your portfolio or you don't, because we've seen high-quality bonds, in particular government bonds, posting gains at a time when most equities have had losses. So, make sure that you have a decent amount of diversification in your portfolio.

Here again, I think the concept of time-horizon framing can be helpful for retirees. I often tell retirees to think about having one to two years' worth of living expenses in cash. Maybe money for years two through eight of retirement you want to have in a high-quality bond portfolio mainly, because equities are not reliable over time periods less than 10 years. So you want to have that money parked in bonds--primarily government bonds, Treasuries, mortgage-backed, some sort of a high-quality portfolio. Then money where you do have a time horizon that's longer than 10 years, that money belongs in stocks.

So, take a step back, think about your time horizon for your portfolio, and position it accordingly.

Glaser: Retirees may not be able to save more, but they can spend less. Are these times of market turmoil a good time to revisit your spending rate?

Benz: I think they are, because it's one thing that retirees can do to gain a sense of control in tough market environments. It doesn't mean that you have to absolutely upend your spending plan--you don't need to call off that vacation or start looking at smaller places to live.

But it is a great time to get in there and think about your spending strategy, make sure that whatever spending strategy you are using passes a sniff test of sustainability--and of course, there are a lot of different ways to look at the issue of sustainability.

One thing I often hear from Morningstar.com users is that they like to take fixed rate withdrawals from their portfolios. They use 4%, say, year-in and year-out, and that has the benefit of tethering them to whatever is going on in the markets and their portfolios. That might be one strategy to consider, provided that you are comfortable with a little bit of fluctuation in your spending, if you're willing to pull back in tough markets.

If retirees are using, say, the 4% rule, where they are taking a fixed dollar amount from their portfolio and then only gradually nudging that up to keep pace with inflation, they might consider forgoing the inflation adjustment. Inflation has been generally benign, and that is something that you can do to improve your portfolio sustainability in tough market environments. This came out of a T. Rowe Price study a few years back where they looked at strategies to help improve portfolio sustainability. They found that simply forgoing that inflation adjustment in weak market environments was surprisingly powerful.

Glaser: Finally, what would be another to-do for retirees?

Benz: I think it's really valuable--also in the category of focusing on what you can control--to look at small-bore factors that we can exert some level of control over. This would mean taking another look at your all-in investment-related expenses--fund expense ratios--and possibly swapping into more index funds and exchange-traded funds. Minding your own transaction costs: If you're paying brokerage commissions to trade, make sure that you're not trading more than you need to.

And also keep an eye on tax efficiency, because tax efficiency is in the category of something that we investors exert some level of control over. So pay attention to asset location, meaning which types assets you have stored in which types of accounts. If you're actively withdrawing from your portfolio during retirement, make sure that you're sequencing those withdrawals with an eye toward reducing the drag of taxes, and here is a spot where a tax advisor can really add a lot of value.

Also, if you have taxable accounts, and many retirees do, make sure that you're managing them with tax efficiency. For many retirees that will mean index equity funds, maybe individual stocks as well as municipal-bond investments.

Glaser: Christine, thank you for sharing those retirees to-dos with us today.

Benz: Thank you, Jeremy.

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