Benz's Retirement Planning Outlook at Midyear

Susan Dziubinski: For Morningstar, I'm Susan Dziubinski. We are midway through 2018. Here to discuss what's been going on with retirement planning is Christine Benz. She is our director of personal finance on Morningstar.com.

Christine, thanks for joining me.

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

Dziubinski: One of the positive developments we've been seeing this year are in large balances in 401(k) plans and investment plans and improving investor confidence, is that right?

Benz: It is right. When we look at the data that Vanguard and Fidelity provide, both show in large participant balances in the 401(k) plans that they oversee. The average 401(k) balance for both firms was just over $100,000 for the average 401(k) participant. The number I really like to see was for people who have been participating in Fidelity-managed 401(k) plans for at least 15 years. The average balance was $380,000 as of their most recent data run. That's up significantly from the year prior. It's an encouraging number. As you say, those enlarged balances often translate into improved retiree and pre-retiree confidence.

The Employee Benefit Research Institute puts out an annual survey of retiree and pre-retiree confidence. Two out of three pre-retirees said that they felt at least somewhat confident in their own ability to retire. Retirees were feeling really comfortable on the viability of their plans. A third of people already retired said that they were feeling very confident that their plans would last, that their money would last throughout the retirement years, and 44% of those retirees surveyed said that they were at least somewhat confidence. A lot of things lining up to make people feel more comfortable about making retirement work, which is great news.

Dziubinski: That is great. But you have been talking about some risks for pre-retirees right now. Can you talk a little bit about that?

Benz: There are. I've written about how I'm concerned about this new cohort of people just getting ready to retire. Because in a lot of ways there's a lot to make people feel like they are ready to retire. One thing we know is that when balances are up, valuations are often on the high side. Another thing that retirees have to keep an eye on is the fact that starting bond yields are still quite low today. Even though we've seen yields kick up a little bit recently, the combination of factors that would help new retirees really grow their balances in the decade ahead are not really working in their favor. I do think that they need to be careful and they need to be ready to make some changes if their retirement date happens to coincide with a lousy market environment.

Dziubinski: What could an investor do to mitigate some of these risks?

Benz: A couple of key things. One is making sure that they have adequate liquidity, adequate cash cushion set aside in their portfolios to tide them through weak performance from the stock market or the bond market or both. That's a good starting point. Revisiting asset allocation, taking a look at your portfolio, using our X-Ray tool on Morningstar.com. Seeing where you are in terms of your positioning relative to your targets is a great strategy, especially because as investors we naturally get a little bit complacent when equities have been so good for so long as they have been recently.

Another key thing to keep in mind is, if you are someone who is just starting to retire, and you are drawing from your portfolio, plan to be a little bit flexible in terms of how much you will draw from your portfolio. The best way to tide your portfolio through a period of weak market returns is to make sure that you are not pulling too much from that portfolio. Ideally, you'd go into retirement with a little bit of wiggle room with that spending rate and the ability to tighten your belt if you encounter a weak market environment.

Dziubinski: You've alluded to this earlier. We have seen rising yields this year. What should retirees really make of that? Should they be worried that it's going to somehow derail their plans?

Benz: There's a lot of concern out there. I guess, it depends on what you're invested in. If you are a cash investor, higher yields are an unmitigated positive for your portfolio. You can now find one-year CDs that are yielding over 2%. You can find online savings accounts that offer a lot of liquidity and FDIC protection for 2% as well. It's great news for cash investors.

Bond investors have had to endure a little bit of price volatility in their portfolios even as they have seen higher yields come online. I do think it's worth taking a step back, thinking about why you are holding bonds in your portfolio. Over time, higher yields, as they do become available, should be good for you as a bond investor even though they cause a little bit of volatility in the short term. I do think that bonds' position as ballast for equity portfolios still stands. Even in a terrible period for bonds, it will be nowhere near as bad as the havoc that a weak equity market can wreak on a portfolio. I think that perspective is really valuable.

Certainly, you want to make sure that you are not taking too much risk in your bond portfolio. I wouldn't be venturing into long duration bonds at this point. I'd also be careful about taking too much credit risk in a bond portfolio, particularly given that this market recovery, the economic recovery that we've experienced has been going on for so long. I think you wouldn't want to be positioned with an overly credit-sensitive portfolio at this point in time.

Dziubinski: Investors--pre-retirees and retirees--shouldn't necessarily be fearful of bond funds right now?

Benz: Not necessarily. But I think they need to pick their spot. Don't venture into some of the riskier bond types that we just talked about.

Dziubinski: Got you. Now, another set of sobering data, as if what's going on in the market isn't enough, are the numbers you see around healthcare costs in retirement. Let's talk a little bit about that.

Benz: Fidelity annually has been putting out this benchmark of what a 65-year-old couple should expect to spend out of pocket in healthcare costs over their retirement lifespan. The most recent run at the data had the figure at $280,000 over that retirement life cycle. The really scary thing is that that doesn't encompass long-term care costs. It's a big number. Vanguard recently decided to conduct some research along these same lines, but they are coming at it in a slightly different way. They are trying to help retirees estimate how much they would expect to spend per year in retirement. Vanguard's data set was pointing to an annual outlay of $5,200 per year for a 65-year-old woman, and they are assuming that the woman has purchased a supplemental insurance policy to go along with Medicare as well as Medicare Part D, the prescription drug coverage. These are two benchmarks. Certainly, big numbers and something that retirees can use to help aid in their planning in terms of how much they will spend from their portfolios in terms of healthcare costs.

Dziubinski: Regardless of whether it's Fidelity's approach or Vanguard's approach, those are big numbers. What types of things can investors be doing to prepare for those costs?

Benz: Definitely factor them into their budgets. I think as people get close to retirement, it's really crucial to look at how healthcare costs might change relative to when they are working. A lot of people say, aha, I'm covered by Medicare, now I'm home free. Well, not necessarily. There are other costs that will crop up necessarily in retirement. It's important to make sure that you are factoring them into your spending plan. Also, bear in mind the fact that we have recently seen healthcare inflation tick up a little bit. We had been through a period where healthcare inflation was actually looking pretty mild. We are seeing it flare up again. That accentuates the case for making sure that you are minding inflation pressures when thinking about portfolio, making sure that you are adding those inflation hedges to your portfolio.

Dziubinski: Lastly, we've seen a return of volatility to the market this year. Specifically, what are some things that retirees can do to cope with that market volatility?

Benz: I mentioned earlier on, Susan, the idea of having those liquid reserves. As you know, I'm a big fan of this Bucket strategy and the central underpinning of the Bucket strategy is having ample liquid reserves--not too much--but one to two years' worth of portfolio expenditures in true cash investments I think is a good starting point. Revisiting asset allocation is another good starting point. Doing some strategizing around tax planning, I think, is another way to kind of take back control in an uncertain market. We now have some clarity on tax rates at least until 2025. I think it's a great time for retirees to strategize with their tax advisors about where best to pull their assets from, pull their portfolio withdrawals from in an effort to keep taxes down. Definitely try to keep your focus on things you can control versus getting caught up in the day-to-day market noise. Because it obviously can be very disconcerting when you are in drawdown mode in particular.

Dziubinski: Christine, thank you so much. This was a terrific overview.

Benz: Thank you, Susan.

Dziubinski: For Morningstar, I'm Susan Dziubinski. Thanks for watching.