After nine years of a bull market, can investors be blamed for feeling good about their portfolios' performance? Perhaps not, but that doesn't mean they should be complacent. We sat down with Morningstar Director of Personal Finance Christine Benz to discuss the key pitfalls of a lofty market and the steps investors can take to avoid them.
When the market is so high, there can be a bit of a wealth effect--it makes you feel like you want to spend more, you feel wealthier. This is something that you think investors really should guard against though.
Benz: It's important at every life stage, but particularly for retirees, to make sure that you are not letting your inflated portfolio balances go to your head. When we think of the key things that make or break a retiree's plan, the most impactful is the spending rate from the portfolio.
It's natural to feel more comfortable with spending more from your portfolio when your balances enlarge than you otherwise would. That accentuates the virtue of operating with some sort of a withdrawal rate system that makes sense given your portfolio's asset allocation, given your time horizon, and make sure that it's something that you are revisiting on an ongoing basis.
I sometimes talk to retirees who say that they are using fixed percentage withdrawals from their portfolios because it tethers them to whatever is going on in their portfolios. I would point out that those fixed percentage withdrawals are really nice to employ when the market is going up, but just bear in mind the repercussions when the market goes down. If that's your strategy and say, you are pulling 4%, or $40,000, annually from a $1 million portfolio, think about how it would feel to pull $28,000 from a $700,000 portfolio. Just be careful. Make sure that you are using a system.
I really like the idea of committing your withdrawal rate system to some sort of a document. We've got a retirement policy statement template available on Morningstar.com. I think people should use a template like that to make sure they are on track and not getting buffeted around by their portfolio balances.
Next step: Create a Retirement Policy Statement
Let's talk about portfolios. We often advocate a pretty hands-off approach. But when you are in this kind of a bull market, you can be too hands-off.
That's a big risk for retirees today. If they have been very hands-off for many years now, they have ended up with portfolios that have gotten progressively more equity heavy, and in turn they have higher volatility potential in their portfolios. I do think that retirees who have not done so recently should take a look at their asset allocation.
First, retirees will want to check whether they have enough in safe assets to tide them through a difficult period in the equity market. I usually urge retirees to back into an appropriate asset allocation mix using their planned portfolio withdrawals.
In my model portfolios, for example, I suggest two years' worth of portfolio withdrawals and steering that to cash; another eight years' worth of portfolio withdrawals in bonds; and then the remainder of the portfolio could reasonably go into more aggressive, high-returning assets like stocks. But make sure that you have those near and intermediate-term reserves set aside.
If you haven't done that sort of portfolio maintenance recently, you are probably overdue to do it.
Next step: Check Your Portfolio's asset allocation with Morningstar's Portfolio X-Ray.
Zooming in on that equity portion, you could be too hands-off there as well. There could be some misalignment just within that portion.
Benz: Absolutely. We have had a period, especially in 2017, where growth has looked unassailable. Growth stocks have been performing tremendously well. And there again, if you have done nothing, if you have been hands-off with portfolio, it's a good bet that that portfolio might be listing toward the growth side of the style box. Many investors, though, have actually been actively adding to the growth components of their portfolios. That would tend to give their portfolios an even more growth-heavy look.
But don't overlook the value side of the style box. Don't overlook high-quality stocks, which haven't performed particularly well. I think of Vanguard Dividend Growth (VDIGX), for example, which is a fund that I own in my model bucket portfolios. It had a year to forget in 2017, but I still think it's a stellar core holding. Those are the kinds of things that investors shouldn't give up on even though they haven't performed especially well relative to growthier names in their portfolios.
Next step: If you need to beef up the value exposure in your portfolio, start with Morningstar's Premium list of Best Investments: Value Funds. The top-rated funds on this list are all open to new investment today.
Morningstar does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.