Retirees: Avoid These Traps in Turbulent Markets

Editor's note: Morningstar.com's annual Portfolio Makeover Week showcases real-life strategies for navigating the most common investing questions. Our 2019 makeovers will feature the before and after portfolios of five investors at various life stages and asset levels. Complete this form by Sept. 30 for your chance to have your questions answered and your portfolio profiled by Christine Benz.

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Susan Dziubinski: Hi, I'm Susan Dziubinski for Morningstar.com. The market has been experiencing some turbulence, and a widely used recessionary indicator is flashing red. Joining me to share some counsel for retirees managing their portfolios, and specifically some mistakes to avoid when the market gets rough, is Christine Benz. Christine is Morningstar's director of personal finance.

Christine, thank you for being here with us today.

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

Dziubinski: Now, one thing that we investors often hear is that you tune out the noise and don't pay attention to the market turbulence. But you say doing so could be a mistake. What should we be doing? We shouldn't just stand there; we should do some due diligence?

Benz: It really depends on your life stage. So, I love that advice of not peeking or not just doing something but standing there, makes all the sense in the world for people who are accumulating assets for retirement. But in the years just leading up to retirement or when you're actually retired, you need to get serious about adding some risk controls to your portfolio, adding some lower-risk investments. So, I think that people who haven't checked up on their portfolios recently who are at that life stage of drawing down their portfolios or getting close to it, should absolutely use recent market volatility as an impetus to get in there, check up on their allocations to safer securities. Because if they haven't been topping them up along the way, their portfolios could be getting too equity-heavy and aggressive.

Dziubinski: Now, sort of, on the flip side, another thing, another mistake some of us make is, we start to overdo the safe securities in our portfolios. Let's talk a little bit about that.

Benz: It's absolutely a balance. So, certainly, there is some appeal in investing in something that you don't think will go down, especially when equities are showing some volatility. You don't want to overdo it. That's the key point. Because starting yields on bonds, say, you're looking at a bond fund with a 2%, 3% yield. Well, that's about what you can expect to earn in terms of your total return from that investment over the next decade. So, that's a low rate of return, may not keep up with the inflation rate. So, you want to be careful about the allocation to safe securities. I typically recommend that people who are in drawdown mode, so already pulling from their portfolios, build themselves a runway of roughly 10 years' worth of portfolio withdrawals in cash--maybe two years' worth of portfolio withdrawals in cash, and another five to eight years' worth of portfolio withdrawals in bonds. Any more than that, I think, you are staking too much in very safe securities with low long-term return potential.

Dziubinski: Another thing you advise against is getting too tactical, practicing tactical strategies in this type of market. And that does sound appealing on the surface, especially when you have volatility present.

Benz: That's right. So, just to quickly outline what a tactical strategy means, it kind of means that you jump around a little bit based on your expectation of how various asset classes would perform. So, right now, you might say, "Aha, you know, we've been through this long-running bull market for equities, recession fears are coming up, maybe it's time to get out of stocks, go into cash and bonds, and then at a later date I'll increase my equity allocation again." Sounds great. In practice, that can be super difficult to pull off. We often look at professional tactical asset allocators, and they've had a difficult time executing tactical strategies consistently. So, I would be really careful about market-timing or employing tactical strategies. If you do invest in a fund that employs a tactical strategy, and there are some decent ones out there, I think even there, you want to be judicious about your allocation to it. You probably don't want to put your whole portfolio into it, because it will inevitably have some fallow periods. You probably want to just stick with a strategic long-term asset-allocation framework for the bulk of your portfolio.

Dziubinski: Another trap that we fall into might involve overdoing it with alternative investments when we have market volatility, because it's certainly appealing to want to dedicate some money toward an alternative investment that's maybe going to stay flat or go up a little bit as the market is going down.

Benz: Right. The idea is that you'll have something that is not correlated to either the stock or the bond market. That's the idea behind an alternative strategy. In practice, we haven't seen a lot of environments that have truly stress-tested alternatives. But in the recent past, when we have had difficult markets--I would go back to the fourth quarter of 2018, for example--alternatives haven't overwhelmed with great performance. So, I wouldn't stake too much, if anything, in alternative investments. They haven't necessarily made a great case for themselves and then they also have the headwind of very high costs in some cases. So, you're looking at an asset class that if it performs well should probably deliver a return somewhere between stocks and bonds. But when you're paying 1%, or even 2%, for the privilege of owning that investment that might give you 4% or 5%, I don't like the trade-off there. So, I don't think investors should overdo their allocation to alternative investment types.

Dziubinski: And the last mistake to avoid in markets like this involves time management. What do you mean by that?

Benz: Well, in retirement, you do have typically--although I know a lot of busy retirees--sometimes you have some extra time. And that can mean extra time to watch CNBC or watch other financial programs, to spend too much time on financial websites as much as we love to have retirees on Morningstar.com, it can make you too consumed with what's going on in your portfolio. If you get out and about do things unrelated to your portfolio, that gives you context for what's going on in the market. And I think it also is a little bit of a distraction. It can keep you from making changes that you might in hindsight regret that you made. So, my advice is to do maybe quarterly, twice yearly, even once yearly portfolio checkup, but any more than that, I think, is overkill. Try to stay away from your portfolio. Try to stay away from the news flow even though it can be tempting to plug in.

Dziubinski: Christine, as always, great guidance to keep us focused on the long term and our goals. Thanks for being here today.

Benz: Thank you, Susan.

Dziubinski: I'm Susan Dziubinski for Morningstar.com. Thanks for tuning in.