Morningstar Advisor - December 2010/January 2011 - (Page 45)
Building In-Retirement Portfolios to Last
By Christine Benz
These model portfolios will help retirees battle today’s challenges and risks.
A few decades ago, retirees could reasonably hunker down in certificates of deposit and other safe investments and generate a livable income. But that formula has been turned on its head for today’s retirees. With the setback caused by the financial crisis and cash and bond yields as low as they are, as well as the fact that many retirees could be drawing on their portfolios for a few decades or more, sticking with the safe stuff just isn’t going to cut it unless a client has a very high level of wealth. Instead, retirees have to be more creative and willing to be a little more aggressive to build portfolios that will last a lifetime. In the first Spotlight article, we discussed how to allocate a portion of a retirement portfolio to products that guarantee investors an income stream for life. Here, we’ll discuss some investment ideas, including an aggressive strategy, for retirement portfolios made up of traditional assets such as stocks and bonds. We’ll create three model portfolios for retirees based on time horizon and risk tolerance. Before we get into the specifics, here are some general guidelines about the portfolios.
into principal to fund living expenses rather than living solely off of the portfolio’s income stream. Yields are so low currently that investors would need to take on extreme risk to generate a livable income stream at this point.
aggressive with their equity stakes than what we’re recommending. Of course, individual circumstances vary, and advisors should make the appropriate adjustments for their clients.
Strategic, Not Tactical
These portfolios are designed to be strategic, meaning that shares are meant to be bought and held rather than traded. We have yet to see a compelling case for tactical management. Most investors fail to correctly time market moves. That said, we didn’t completely ignore the current market environment in putting these portfolios together. We’ve downplayed Treasury bonds in the fixedincome portfolios, for example, largely because Treasuries still remain pricey relative to other types of bonds. On the stock side, we’ve emphasized funds that invest in high-quality companies, based on their current valuation and abilities to prosper in a slow-growth economy.
The Role of Cash
You’ll also notice that we didn’t include cash in the mutual fund portfolios. We believe that it’s an individual decision based on the size of a client’s portfolio, other income streams available, and living expenses. In general, retirees should hold two to five years’ worth of living expenses in cash. (Given paltry cash yields, investors may want to keep their cash stake at the low end of this range and park additional assets that they’d like to keep safe in a high-quality short-term bond fund such as Vanguard Short-Term Bond Index VBISX or T. Rowe Price Short-Term Bond PRWBX.) The ETF portfolios contain limited amounts of cash holdings, because we based their asset allocation on the Morningstar Lifetime Allocation Indexes. The indexes include cash because it improves the portfolio’s overall risk/ return characteristics, not for liquidity purposes.
Other Income Sources
It’s important to note that we created the following portfolios as stand-alone portfolios and not as part of an optimized portfolio that includes annuities or other guaranteed income products. Investors who have a high percentage of pensionlike income (via traditional pensions, Social Security, and insurance products) might be able to be more
A Conservative Model Portfolio
Time horizon: 10 years Risk tolerance: Very conservative Goal: Modest return with limited level of volatility Target allocation: 25% stocks/75% bonds
Total Return, Not Income
The portfolios focus on providing total return rather than generating current income. That is, they assume that the investor may dip
Table of Contents for the Digital Edition of Morningstar Advisor - December 2010/January 2011
Morningstar Advisor - December 2010/january 2011
New on morningstaradvisor.com
Letter From the Editor
What Strategies Do You Use to Help Retirees Hedge Against Longevity Risk?
Four Picks for the Present
Scaring the Swiss
Tech Is the Apple of Managers’ Eyes
How to Read an Sec Filing
A Strategy That Loves Performance Chasers
Things Fall Apart, Even in Industrials
A Future in Questions, Not Answers
Research Over Chocolates
Creating Portfolios That Confront Retirement’s Risks
Building in-Retirement Portfolios to Last
On the Lookout for Guaranteed Income Streams
What Fires Up Mairs & Power
Aiming at Alternatives
Stuff Your Stocking with Out-of-Favor Bargains
Stable, High Yields (No Bonds Included)
Mutural Fund Analyst Picks
50 Most Popular ETFs
Undervalued Stocks with Wide Moats
Twelve Bee, Huh?
Morningstar Advisor - December 2010/January 2011