This week marks the end of one tax year, and the beginning of the new 2017/18 tax year. For investment ideas, back to basics education and advice from the experts read Morningstar’s Guide to Planning for Retirement.
Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. Many retirees and those about to enter retirement are looking for ways to de-risk their portfolios but might be concerned about going into bonds or cash at very low yields. I'm here with Christine Benz, she is our director of personal finance, to look at some chicken ways of de-risking your portfolio.
Christine, thanks for joining me.
Christine Benz: Jeremy, great to be here.
Glaser: So, let's talk about maybe the first is the gold standard of how to de-risk, which is rebalancing, going into those stocks and bonds. Why do you think that this is still the best way to take risk out of your portfolio?
Benz: Well, first, I would say there is a lot of confusion about what rebalancing does and doesn't do for your portfolio. Some investors assume, well, if they are telling me to rebalance, it must enhance my returns in some way; not really. When we look at some of the academic research that's been done on the virtues of rebalancing, most of it points to rebalancing being a risk-reduction tool.
So, the basic idea is that you are looking at your portfolio's asset class exposures and you are taking them back to your target allocation. And this has the virtue of helping you sell your most appreciated positions and to things that potentially are a little bit depressed and maybe do for a comeback.
So, academic literature points to rebalancing being valuable from the standpoint of risk reduction. One thing to think about is that portfolios that haven't been touched--and I know a lot of investors have been pretty reticent to touch their portfolios, to sort of pull back on stocks when stocks have performed so well for so long--but the untouched portfolio is probably listing pretty heavily towards stocks at this point.
So, if you were 60-40 coming into this great rally that we've had in the equity markets--so you are 60% equity, 40% bond--today you'd be roughly 82-20 and you are eight years older. So, that might mean that you should in fact think about scaling back on stocks and putting some money into the safer stuff in your portfolio.
Glaser: But even with that big run-up and concerns about valuations, we hear from retirees who say, yes, stocks are looking expensive but bonds look even worse. What would be a way to kind of do that rebalancing that maybe would be less painful?
Benz: Well, one thing to think about, and this is a form of rebalancing, but the idea would be, if you have to figure out where you are going to spend from your portfolio, so if you're in drawdown mode, one idea would be to think about spending from your most appreciated portions of your portfolio. That will probably be your equity holdings, but use those withdrawals from those holdings to help meet your required minimum distributions, to help meet your annual spending needs. This is a way that, I think, retirees can maybe psychologically cope with this idea of trimming back on the appreciated pieces of their portfolios.
Glaser: You say another option is to spend the dividends that you receive instead of reinvesting them?
Benz: Right. I think a lot of us, I know, me included, when I set up accounts I kind of reflexively check those boxes that say, yes, I want to reinvest my dividend and capital gains distributions. But actually, withdrawing those distributions can be a good way to kind of at least not add more to those positions that have appreciated. So, this is something to consider with your equity holdings if you are in drawdown mode. It gives you a little bit more control over your withdrawals and helps keep you from plowing more money into securities that have already enjoyed a nice runup.
Glaser: Another option could be to let someone else do it. What are some of the pros and cons of going for an allocation or all-in-one fund that hold both stocks and bonds and letting them manage that difference?
Benz: I've actually been critical of these all-in-one funds for retirees who are in drawdown mode. And the key point that I've made is that all else equal you'd rather have some control over where you go for your withdrawals. So, by having discrete stock and bond holdings – rather than having them all under the hood of a single vehicle – you are in a position to actually say, well, today I want to withdraw from my equity holdings, maybe in a few months I will prefer to withdraw from my bond holdings. You actually have more control.
And I've run some back tests on this question about whether you're better off having discrete stock and bond holdings or using some sort of even a very good all-in-one fund, and I have found that there are some benefits to being able to do that very specific pruning from stocks or bonds at any given point in time.
Glaser: Christine, thanks for your thoughts on de-risking today.
Benz: Thank you, Jeremy.
Glaser: For Morningstar, I'm Jeremy Glaser. Thanks for watching.
