Our Favorite Equity Funds for Retirement

Christine Benz: Hi, I'm Christine Benz for Morningstar.com. Most investors hold substantial exposure to stocks well into retirement. Joining me to share some favorite stock funds for retirees is Russ Kinnel. He is Morningstar's director of manager research.

Russ, thank you so much for being here.

Russ Kinnel: Glad to be here.

Benz: Russ, let's just start by talking about why retirees should make room for stocks in their portfolios.

Kinnel: Yeah, it makes sense to dial down your stock exposure a little bit, but not dial it out because obviously, you can be in retirement for a long time. You need to keep up with inflation. Equities are a good way to do that. So, you may want to adjust your equity positioning, but you really need it for just about all retirees.

Benz: Right. Especially when you consider that retirees are retired for maybe 20 or 30 years or even more.

Kinnel: That's right. You need your capital to grow at least in some parts of your portfolio.

Benz: When you think about funds, equity funds that you think are good choices for retirees, what characteristics are you looking for? It sounds like maybe ones that manage risk a little better?

Kinnel: I want funds that have some components that manage risk well. I screen for funds that have low Morningstar risk scores, which means they're less volatile than their peers. But of course, it doesn't mean no risk. If you have a fund that's 80% or 90% equities and you have a bear market, of course, it's going to lose money, depending on--each bear market is different, but they're not risk-free by any stretch. But I think most retirees need to take on some risk to get to their goals.

Benz: Let's take a look at some of the funds that have low risk and that you like overall that have good analyst ratings, starting with T. Rowe Price Dividend Growth PRDGX. Maybe start with what is a dividend growth strategy because the dividend in absolute terms isn't especially impressive on this fund or any other dividend growth fund.

Kinnel: That's right. So, on the one hand, you have equity income, which is a deeper-value, higher-yielding strategy. Dividend growth is about companies that have a dividend but can grow that dividend. And obviously, to do that you have to have pretty healthy balance sheets and some good growth prospects. So, that takes--most of these funds are large blend funds and they have some growth and value characteristics. But it turns out that's also a really good defensive characteristic because those are the sort of companies that generally held up well in a downturn. So, we saw that in '08-'09 a lot of these funds lost less than the overall market.

Benz: This one is Silver-rated. Vanguard also has some good products in this general strategy, its Dividend Growth and Dividend Appreciation fund. Let's talk about a fund that I think of as being a little bit more idiosyncratic. This is AMG Yacktman YACKX. But it's a fund that you think nonetheless is a good fit for retirees' equity portfolios.

Kinnel: That's right. This fund, you think focused equity portfolio. That doesn't sound low risk at all. And to be sure, there is some individual security risk. But the fund tends to hold cash. Also, it's got a valuation and quality bent so that that tends to reduce risk. Again, it's not going to be risk-free. It's going to lose money in a bear market. But I think they've done a really good job of security selection as well as being risk-averse enough to generally lose less in downturns.

Benz: Another fund that you like for retirees' equity exposure is Fidelity Low-Priced Stock FLPSX. This is a familiar name, but let's just go over why you think it is a sensible choice, especially for people who want to make sure that they have small- and mid-cap exposure in their portfolios.

Kinnel: In this case, part of the risk management is that it's a very diffuse portfolio, really covers small- and mid-caps, value and blend, hundreds and hundreds of names. And generally, though, that leads to a fairly modest risk profile. Joel Tillinghast is the longtime manager of this fund, does a kind of amazing job of finding good quality companies trading at fairly modest prices. And if you look over the long history of the fund, it generally holds up pretty well in downturns.

Benz: One thing we always discuss in the context of this fund is, Joel Tillinghast is a veteran manager. He's been on the job for a long time. Anytime you're looking at a fund like that, I think it's worthwhile to think through succession strategy. Has Fidelity given any indication about what the next steps will be on that front?

Kinnel: Well, they have some comanagers listed who run a small sleeve of the funds. So, I think, presumably, they would take that over. And I wouldn't be surprised if--they haven't officially said that, but presumably they would take that over. So, you would probably have a number of people running the fund. Doing what Tillinghast does on his own is just about impossible for a normal person. He's just an extraordinary investor, just a remarkable investor. And so, you really would have to hand it off to a lot of people. So I agree, you want to watch that closely because it will be a different fund when Tillinghast retires, but we hope he doesn't retire soon because he does such a good job.

Benz: Your last idea is a fund that has some overseas exposure. Let's talk about that particular fund, but also how retirees might approach that question of how global their equity portfolio should be.

Kinnel: Foreign sounds risky, and it can be, but not as risky as our perception is. I think for most people it makes sense to have some exposure. Tweedy, Browne Value hedges a lot of their foreign currency exposure, so at least you don't have as much currency risk and therefore less volatility. They've got a mix of U.S. and foreign equities, and it's very much a value-driven strategy, which mutes risk a bit. It's a fairly diversified portfolio, that also mutes risk a bit. And they're just good stock-pickers. We're working on the second generation at Tweedy, but they really do a good job of building up their analysts and manager staff so that the transition's been a pretty smooth one.

Benz: Russ, thank you so much for being here to discuss these picks with us.

Kinnel: You're welcome.

Benz: Thanks for watching. I'm Christine Benz for Morningstar.com.