Tips for Winning the Retirement Income Battle

This analyst blog is part of our coverage of the 2017 Morningstar Investment Conference.

Baby boomers have reached retirement age--the oldest of the group turn 70 this year. That's a lot of people--75 million or thereabouts--who'll need income in retirement.

Meanwhile, interest rates remain stubbornly low: Gone are the days when retirees could live off the income from their bonds. As each day goes by, more and more investors are scrambling to generate income in retirement.

The retirement income dilemma was the subject of a panel discussion led by Morningstar's Leo Acheson at the 2017 Morningstar Investment Conference.

Franklin Templeton's Ed Perks is feeling good these days about income investing--in fact, he described himself as the "happiest guy in the building." Perks noted that we've seen a pretty significant move up in interest rates in the past six to nine months; it's a big change from just a year ago at this very conference, where the talk was about negative interest rates.

Further, said Perks, the opportunity set among dividend-paying stocks has widened during the past few years as more companies pay dividends. Although dividend-paying stocks have generally outperformed the broad market, Perks remains a fan of them versus bonds today.

Fidelity's Brett Sumsion likes dividend-paying stocks, too, and noted that rising rates aren't necessarily bad news for them.

"The conditions behind rising rates matter for how securities perform," he says. For instance, if strong economic growth leads to rising rates, that can be good for dividend-paying stocks. And rising rates are certainly good for dividend-paying banks.

The challenge for retirees, of course, is finding sustainable income that doesn't put principal at too much risk.

After all, as Capital Group's Andrew Suzman pointed out, yield in and of itself isn't that hard to find.

"You can find yield, but that doesn't mean you're playing defense," he said. In other words, there are lots of high-yielders out there, but their dividends are by no means sustainable.

"We're at a pivot point: Stock selection is going to matter tremendously here."

Sumsion also stressed the value of income diversification. He admits that his bias today is for higher rates, so he’s avoiding long–duration securities, and he's more exposed to international securities than in the past.

"We have a recipe for a good change," Sumsion said, between the political environment and an upward movement in rates. But there's a chance that the demand for U.S. bonds will persist, if foreign investors continue to reach for the better yields that U.S. bonds offer. That could continue to suppress bond yields. "The only free lunch is diversification."

"In retirement, there's a strong case to be made for balance," agreed Suzman.

That said, will we ever see a day when bonds yield 5% and retirees can go back to using bonds to meet their income needs?

Sumison noted that rates are low because of a structural phenomenon--and getting back to 5% would likely come from some sort of structural change. A recipe for higher prices can lead to inflation, which may lead to normalized rates in that range.

According to Suzman, contrarians would say that the global deflationary pressures are so strong that a 5% bond yield is a fantasy. But he believes that governments around world are going to try to produce some inflation. Will that be successful? That remains to be seen.

"But I invest in companies that have products and services that there are demand for," said Suzman. "That’s the real margin of safety in this situation."