Planning to Retire Soon? Flexibility and Spending Count

Ivanna Hampton: Here’s what’s ahead on this week’s Investing Insights. Earnings season has kicked off. How JPMorgan’s results are reinforcing Morningstar’s long-term view. Plus – the mistake one equity analyst thinks Warner Bros. Discovery is making with its streaming service revamp. And – it may not feel like the right time to retire. Morningstar Inc’s director of personal finance Christine Benz offers tips to help navigate this economic environment.

This is Investing Insights. Welcome to Investing Insights. I’m your host, Ivanna Hampton. Let’s get started with a look at the Morningstar headlines.

Recent banking industry turmoil didn't hurt JPMorgan Chase's profits. The big U-S bank added more depositors in the first quarter. Its earnings beat the average Wall Street analyst’s expectations and Morningstar’s estimates. Fees came in stronger than expected. And so did net interest income or what a bank earns from making loans. JPMorgan raised its full-year outlook for net interest income. Morningstar views the results as a positive. They also support the analyst’s position that JPMorgan can fend off competition for 20 years or more. Morningstar thinks banks will get through the turmoil. They remain undervalued.

Delta reported a 50% uptick in passenger revenue in the first quarter compared to the same period in 2019. However, the airline’s soaring operating costs have hurt profits and disappointed investors. Delta should do well the rest of the year because of strong summer bookings and an improving cost picture. The airline is coming off massive disruptions from the pandemic. The list includes training thousands of new employees and renegotiating some supplier contracts. Delta also plans to refurbish its midwestern airport hubs. Its cost structure should improve as those investments are completed. Demand for travel remains very high, and ticket prices are higher-than-usual because of constrained capacity. You'll hear more about what Delta management calls a "constructive industry backdrop".The normally cutthroat airline industry is dealing with supply constraints. Morningstar thinks this “once-in-a-lifetime set of circumstances” could provide airlines with a few years of very strong results. Morningstar still estimates Delta’s stock is worth $60 and considers it undervalued.

Warner Bros. Discovery is combining HBO Max and Discovery+ streaming platforms into one. The new streaming service is called “Max”. It’s set to launch on May 23rd in the U.S. Max’s pricing will remain $10 per month for the ad-supported tier and $16 per month for the plan without commercials. Management is shifting 4K content out of the standard tier into a new one in a surprising move. It's launching a $20-a-month plan called “Max Ultimate Ad Free”. It's surprising because the move resembles Netflix’s price structure. And Morningstar thinks this is a “strategic error”. Max might lose when customers compare the rivals. Subscribers may opt for lower-priced streamers and subscribe to Max only when they’re interested in a particular series. Management reiterated its commitment toward profitability in the direct-to-consumer segment. The company is also focusing on generating free cash flow to pay down debt. Discovery+ will remain a standalone service. Morningstar is standing by its $30 estimate of what Warner Bros.’ Discovery’s stock is worth.

The climate tech industry stands to benefit from an infusion of billions of dollars. The “Inflation Reduction Act” is offering incentives for companies to move toward a low-carbon economy. Investment opportunities are expected for years to come. Morningstar Inc’s editorial director for sustainability Leslie Norton is joining Investing Insights to discuss what’s ahead.

Hampton: Leslie, you’re moderating the Investment in Climate Tech Panel at Morningstar Investment Conference next week. Can you give us a quick preview?

Leslie Norton: Yeah. Happy Earth Day, Ivanna. We have this panel, and the premise of it is that there’s a legislative bonanza for the climate tech industry because of the Inflation Reduction Act, because of the Infrastructure and Investment Jobs Act, and the Chips and Science Act. And this generated enormous momentum for America’s domestic clean energy industry. What is this industry? We’re talking about clean energy generation and grid, we’re talking about carbon emissions removal and decarbonization of the economy, and we’re talking about electric vehicles, new and used, and all kinds of other industries.

Hampton: So, the Inflation Reduction Act is providing incentives to remove greenhouse gas emissions from the atmosphere. Can you tell us what companies could receive?

Norton: Right. Well, one newspaper article called it the US plan to become the world’s cleantech superpower. There are lots of benefits for consumers since this slate of legislation. All these pieces of legislation were announced in the past several months, but they include rebates for families to buy heat pumps and tax credits to install rooftop solar, and of course tax credits for buying electric vehicles, both new and used. But there are lots of incentives for corporate America too, that will benefit hydrogen and energy storage companies, domestic manufacturing, and of course clean energy stock valuations.

Hampton: So the Carbon Tech closed out 2022 with record-breaking year for venture capital investment in a number of deals. What’s drawing private investors to this area?

Norton: Of course, as we mentioned, there’s a slate of legislation in the United States that’s unlocking investment for this area. Climate opportunity accompanies climate risk. One of the big issues last year and also this year is that Europe needed to replace Russian fossil fuels during the Ukraine war. European countries have serious targets for net-zero. Obviously, they’re looking for solutions to the decarbonization issue.

Hampton: Now, we’ve had a bumpy market, rising rates, and recently the collapse of Silicon Valley Bank. What does this mean for climate tech?

Norton: Great question. Silicon Valley Bank was very involved in the climate tech space. I spoke with John McDonough, the analyst at PitchBook who covers clean tech, and what he told me was that larger, more established climate tech startups are obviously going to be able to find alternatives for banking and venture debt. But the problems will arise for smaller, younger startups, the ones that aren’t generating revenue yet. They’re going to find funding more challenging. On the other hand, but, but, but, as people say, there is also increased regulatory support for many climate technologies, so as a result, that’s going to drive the founding of more climate tech startups and their founders who have big dollar signs in their eyes.

Hampton: And I owe you a Happy Earth Day, so Happy Earth Day, Leslie. And it’s coming up-

Norton: Thank you.

Hampton: And it’s coming up on this Saturday. This year’s theme is invest in our planet. What should investors know if they’re interested in sustainable investing?

Norton: Thank you. Good question. There are plenty of places to find great information about sustainable investing. One of the best is, of course, morningstar.com, which is where you’re watching Ivanna and me right now. Have a look on the website, click on the sustainable investing tab. When you look up your fund, you can click on the sustainable investing tab there, or rather the sustainability tab. You can see how we rate the fund and you can see how it screens on a number of issues, such as tobacco or nuclear energy. One of the things I like to tell people is be honest with yourself. Are you investing sustainably to avoid risk or are you trying to align your portfolio with your values? The answer to that matters a lot. You can be in a straight-up equity fund, which probably uses ESG metrics in its investment process. But if you’re looking to make an impact on the world, look for an impact fund and read those fund documents pretty closely.

Hampton: And you mentioned morningstar.com, and you’ve written a editor’s note for morningstar.com for Earth Week. What are a couple of highlights in there that while folks are on morningstar.com should check out?

Norton: Right. We have an array of articles for Earth Week, so thanks for asking. One of them will be on carbon capture technology. That’s a promising climate solution. We have top-rated funds from sustainable investing pioneers, and we have a lot of articles ranging from clean energy fund picks to forestry REIT picks to food and agriculture companies that are doing well on the sustainability front.

Hampton: Well, I hope everyone enjoys what you guys have put out for this week. Thanks for your time today, Leslie.

Norton: Thanks for having me.

Hampton: The topsy-turvy markets and high inflation are making some workers nearing retirement feel uneasy. What can Baby Boomers and other future retirees do to figure out if their plan is on track? Here’s Morningstar Inc’s investment specialist Susan Dziubinski with Morningstar Inc’s director of personal finance Christine Benz.

Susan Dziubinski: Hi, I’m Susan Dziubinski from Morningstar. Inflation and interest rates jumped in 2022, and balanced portfolios made up of U.S. stocks and bonds dropped nearly 20%. And in 2023, economic uncertainty continues to rattle markets, and as a result, many preretirees may be wondering whether now is or isn’t a good time to retire. Joining me to discuss what should be on your preretirement checklist today is Christine Benz. Christine is Morningstar’s director of personal finance and retirement planning.

Great to see you, Christine.

Christine Benz: Hi, Susan. It’s great to see you.

Dziubinski: Let’s start out with talking a little bit about what retirement researchers refer to as sequence of returns. What are sequence of returns and why does that matter when it comes to retirement?

Benz: This is a risk factor that retirement researchers think a lot about. And to sum it up, it’s basically the idea that you would encounter a very bad market, either for stocks or bonds, or maybe both right at the beginning of your retirement. And if you’re overspending during that period, it simply leaves less of your portfolio in place to recover when the markets eventually do. So, the period in history when we really saw sequence-of-return risk was in the mid-1960s to late 1960s, early 1970s. That would have been a really bad time to retire because you had a lot of things conspiring against you. You had rising interest rates, which hurt bond prices; you had a bad equity market shock in the early 1970s; and you had high inflation. So, sort of a trifecta of bad factors aligning against retirees. That’s what retirement researchers are talking about when they’re talking about sequence-of-return risk.

Dziubinski: Some of those things you just mentioned sound a little familiar, Christine. So, based on where we are today in the markets, are those who are thinking about retiring running headlong into what could be a bad sequence of returns?

Benz: Probably if we were talking a year ago, I would have been more worried. The good news is that 2022, even though it was kind of a painful dislocation for all of us in terms of our portfolio values, it set new retirees up, prospective retirees up with a better set of factors than would have been the case a year ago. So, equity valuations maybe aren’t a screaming buy, but non-U.S. stocks still appear to be pretty cheap. And certainly, equity valuations are down a bit. So, that’s good. That sets us up for potentially decent equity returns. The bond piece of it is certainly looking a lot better in part because current yield—starting yields are such a great predictor of what you’re likely to earn from bonds over the next decade. We’re much higher than we were a year ago. And inflation, I would say, is a little bit of a wild card in that, yes, we’ve had trouble getting inflation tamped down in this recent cycle. I would say, retirees would maybe want to think about a slightly elevated level of inflation as they do their retirement planning and think about what the trajectory of their spending might look like.

Dziubinski: If a preretiree, say, someone who is thinking of retiring in the next few years, wants to figure out whether he or she is still on track to retire, what sort of things should they be looking at?

Benz: Well, I would start with spending. I like the idea of really getting quite granular in terms of looking at a budget, not just in your first year of retirement but really plotting it out, taking a look at when maybe some of those lumpier spending items might come online if you think you’ll need a new car in five years, or your house is going to need a roof in seven years, or whatever it is. Put those on the budget and take a look at your spending. Look at how your spending might change or might not change in retirement. Maybe you’re planning to relocate to a cheaper part of the country, whatever it is. Start with spending.

Then subtract out any non-portfolio-income sources that you’ll be bringing into retirement. And of course, the more, the better. If you’re lucky enough to have a pension, that’s a great thing. Many of us will have Social Security to draw upon, although we may choose to delay Social Security filing, so it might not be there for us right at the outset of our retirement. But map all that out what those non-portfolio-income sources look like.

Then the amount that you’re left over with, if you subtract those non-portfolio-income sources from your all-in spending needs, the amount that you’re left over with will be your portfolio withdrawal, and you’ll want to spend some time stress-testing that number. We have been running a study every year where we’ve been looking at what a starting safe withdrawal rate would be for people just embarking on retirement. As of late 2022, we came up with a 3.8% starting withdrawal. And that assumed that someone had more or less a balanced portfolio. It assumed they wanted a 90% probability of not running out of funds over a 30-year time horizon. So, that’s just kind of a benchmark that people can use. And I think it’s important to revisit your withdrawal rate as the years go by.

Dziubinski: What role does age play in what a reasonable starting withdrawal rate might be for you?

Benz: It’s super important. In our research, we do assume a 30-year time horizon as a base case. But if you shorten that time horizon, say, you are 80 and you’re just doing a look at what your withdrawal rate looks like today, you can use a shorter time horizon than 30 years. On the other hand, if you’re a young retiree, if you’re someone who wants to hang it up in your mid-50s or early 60s, you need to be more conservative in terms of that starting withdrawal. I wouldn’t take our 3.8% guidance and run with it because you need to plan for a longer time horizon.

Dziubinski: What about for people who might want to start with a higher starting withdrawal percentage? What should they be prepared to do or be thinking about if that’s really what they want to do?

Benz: Right. I think people might look at that 3.8% number and say, “Oh, that’s $38,000 on a $1 million portfolio. That doesn’t feel great.”

Dziubinski: Right.

Benz: There are some things you can do to eke out a higher starting safe withdrawal rate. One idea would be to be somewhat flexible in terms of your withdrawals. If you’re willing to take less in a bad year like 2022, it might mean that you can take more to start out, and you can probably also take more over the course of your retirement time horizon. So, that would be one adjustment.

Another thing we looked at in our research is the fact that when we look at how retirees actually spend—and I should say that our former colleague David Blanchett did this work where he looked at the trajectory of retiree spending—it’s not a straight line throughout retirement. He found that people often do in fact spend more in the early years of retirement. They spend less as they move through their mid-70s into their early 80s. And the net effect of that spending pattern is that they spend a bit less than the inflation rate. In fact, they spend about 1 percentage point less than the inflation rate as the years go by. So, if you’re comfortable with that assumption that you won’t necessarily move in lockstep with inflation, you may have to tighten your belt a little bit in an inflationary environment, that strategy, too, can support a higher starting safe withdrawal rate.

And finally, the last thing I would touch on is just if you are willing to settle for a lower probability of success than that 90% that’s kind of our base case, you can probably get away with―or you can get away with—a higher starting safe withdrawal amount. And I think people might hear that and say, “Well, no, I want 90% or 100% chance of not running out.” And the good news about taking a lower success rate is, we’re not saying that you have to stick with that withdrawal rate forever. You can adjust. If your starting withdrawal rate turned out to be too high, well then, you can potentially pull it in, pull in your spending in future years. So, that’s another strategy that we explored in the paper.

Dziubinski: And then, lastly, Christine, let’s talk a little bit about asset allocation for those preretirees who are close to wanting to retire. Given the current economic environment we’re in, what should they be thinking about?

Benz: I think they should be thinking about balance. And certainly, our research supports the value of balance. It wasn’t the portfolios with 90% or 100% equity that supported the highest safe withdrawal rates. It was the portfolios with the balanced asset allocations. And the basic idea of having a balanced portfolio that to my mind includes a component of cash is just if a year like 2022 materializes early in your retirement, you’d have some safe assets to draw upon without having to touch the assets that are down. So, if you had cash and short-term bonds in your portfolio last year, those would be great to supply your living expenses. They could get you through that rough patch. And that gets back to the Bucket strategy that I often talk and write about as well.

Dziubinski: Well, it sounds like could be good news for a lot of preretirees who are willing to do the legwork and the due diligence on their portfolios and their whole financial picture that maybe they can retire.

Benz: I think so. And in our research, we hope to send a hopeful message that there are ways that you can make a save. You don’t have to stick with a too-low withdrawal rate. There are tweaks you can make.

Dziubinski: Thank you for your time, Christine. It’s good to see you.

Benz: Thank you, Susan.

Dziubinski: I’m Susan Dziubinski with Morningstar. Thanks for tuning in.

Hampton: Thanks Susan and Christine. Subscribe to Morningstar’s YouTube channel to see new videos about market news, personal finance, and investment picks. Thanks to senior video producer Jake VanKersen and lead technical producer Scott Halver. And thank you for tuning into “Investing Insights.” I’m Ivanna Hampton, a senior multimedia editor at Morningstar. Take care.

Planning to Retire Soon? Flexibility and Spending Count

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