Christine Benz, Director of Personal Finance

January 9, 2021

AAII Phoenix Chapter

Retirement Portfolio Planning in Unprecedented Times

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“The four most expensive words in the English language are, ‘This time it’s different.’”

Sir John Templeton

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What’s not new

• A global pandemic

• 1918 (Spanish flu)

• 1957 (Asian flu)

• 1981 (HIV AIDS)

• High equity valuations

• Low bond yields

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What is new

• A global pandemic

• High equity valuations

• Low bond yields

• Occurring all at once…

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What are the implications for retirement planning?

• Pre- and in-retirement asset allocations

• Withdrawal rates

• Withdrawal method

• Role of non-portfolio assets

• Social Security

• Annuities

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Equity valuations (Shiller CAPE): We’ve seen worse (but not too much)

Source: https://www.multpl.com/shiller-pe

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M*’s equity analysts’ bottom-up view: Market not terribly expensive, but not cheap

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Valuations by sector: Largely overpriced

Economically Sensitive Communications Svc. P/FV: 1.06

Energy P/FV: 0.75

Industrials: 1.19

Technology: 1.19

Cyclical

Basic Materials: 1.16

Consumer Cyclical P/FV: 1.18

Financial Services P/FV: 1.10

Real Estate 1.03

Defensive

Consumer Defensive P/FV: 1.08

Utilities P/FV: 1.02

Health P/FV: 1.10

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Style box: A 2-track market

Source: Morningstar Markets Observer

9/30/2020

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Foreign stocks to outperform? 10-yr valuation-implied return (9/30/2020)

Source: Morningstar Markets Observer

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Other firms see better value overseas, too

BlackRock Investments Institute (September 2020)

➢5% nominal returns for U.S. large caps over next 10 years

➢6.4% nominal returns for emerging markets large caps over next 10 years

➢7% nominal returns for European large caps over next 10 years

Research Affiliates (December 2020)

➢-0.2% real returns for U.S. large caps over next 10 years

➢4.1% real returns for MSCI EAFE index over next 10 years

➢5.7% real returns for emerging markets equity over next 10 years

Vanguard (December 2020)

➢3.7%-5.7% nominal returns for U.S. equities over next 10 years

➢7%-9% nominal returns for non-U.S. equities over next 10 years

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Largest stocks expensive overseas

Source: Morningstar Markets Observer

9/30/2020

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Prospects for fixed income more settled

Source: “Low Bond Yields and Safe Withdrawal

Rates,” Blanchett, Finke, Pfau.

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High-quality bond and cash returns look shrimpy

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And not just to us

BlackRock Investments Institute (September 2020)

➢0.8% nominal returns for U.S. aggregate bond index over next 10 years

➢0.3% nominal returns for government bonds over next 10 years

Research Affiliates (August 2020)

➢-1.1% real returns for U.S. aggregate bond index over next 10 years

➢-.0.6% real returns for intermediate Treasuries over next 10 years

Vanguard (August 2020)

➢0.75%-1.75% nominal returns for U.S. bonds over next 10 years

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Lower-quality bond yields have declined—by a lot

Source: fred.stlouisfed.org

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Return prospects look better, with more risk

BlackRock Investments Institute (September 2020)

➢4.3% nominal returns for U.S. high-yield bonds over next 10 years

➢3.6% nominal returns for USD emerg. mkts debt over next 10 years

Research Affiliates (December 2020)

➢3.9% real returns for USD emerg. mkts bonds (local currency) over next 10 years

Vanguard (December 2020)

➢2.75%-3.75% nominal returns for U.S. high-yield bonds over next 10 years

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What are the implications for pre-retirement and in-retirement asset allocations?

• Retirees balancing competing issues

• They need equities for growth, to support withdrawals and beat inflation

• But too much in equities leaves the portfolio vulnerable to sequence risk

• Sequence risk = the chance of encountering a bad market environment early in retirement

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Does the rising-equity glidepath merit another look?

• In contrast with static or declining-equity glidepaths, rising-equity glidepath starts retirement

conservatively

• Gives retiree protection against sequencing risk by

enabling them to “spend through” safe assets

• “Reducing Risk with a Rising Equity Glidepath”

(Kitces & Pfau, 2013)

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Bucket approach gets at the same idea

Bucket 1

For: Years 1 and 2

Holds: Cash

Goal: Fund Near-

Term Living Expenses

Bucket 2

For: Years 3-10

Holds: Bonds, Balanced

Funds

Goal: Income production,

stability, inflation

protection

Bucket 3

For: Years 11 and

beyond

Holds: Stock

Goal: Growth

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But buckets 1 & 2 carry a substantial opportunity cost

• Other “buffer” assets could reduce need to maintain ongoing stake in low-returning assets (Wade Pfau)

• Standby reverse mortgage

• Life insurance cash value• Alternatively, “bucketed” retiree could simply not

fully replenish buckets 1 and 2 once depleted

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What are the implications for withdrawals?

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Today’s low yields reduce probability of success for 4% guideline

Source: “Low Bond Yields and Safe Withdrawal

Rates,” Blanchett, Finke, Pfau.

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Best practices for withdrawal rates in ultra-low-yield world

• Flexibility is key: Base withdrawals on portfolio balance

• Guyton’s “guardrails”

• RMD method• Factor in the following:

• Asset allocation

• Age

• Portfolio performance/balance

• Actual expenses

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What are the implications for pre- and in-retirement withdrawal methods?

• Income-centric approaches have become untenable

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Equity dividend yields look better but with substantial volatility

• Vanguard High Dividend Yield Index (VYM)

• Current (SEC) yield: 3.17%

• Return 2/19/20-3/23/20: -34%• Vanguard Int’l High Dividend Yield Index (VYMI)

• Current (SEC) yield: 3.06%

• Return 2/19/20-3/23/20: -36%

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Constrained yields should push all retirees into total return camp

• Two possible strategies

• Pure total return

• Reinvest income

• Harvest withdrawals via rebalancing

• Hybrid

• Spend income distributions

• Use rebalancing for additional income needs

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What does this mean for non-portfolio income sources?

• Lower yields make delayed Social Security filing even smarter

• Increase benefits by 76%-77% by delaying from 62-70

• 7.4% annual increase• Impossible to beat that GUARANTEED rate of return

by investing in the market

• Open Social Security: Terrific free tool for testing various Social Security strategies

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Annuities affected by low yields, but still have benefits

• Annuity payouts affected by interest-rate climate

• BUT benefit from longevity-risk pooling unchanged

• Along with Social Security, can be an effective way

to supply fixed expenses, reduce portfolio withdrawals

• Reduces withdrawal rate

• Reduces need for safe investment assets

• Reduces longevity risk

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Other retirement stuff that worries me

• State and local finances troubled

• Social Security Trust fund getting closer to depletion (implications for younger clients)

• Long-term care market still troubled

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Questions/comments

• Christine.benz@Morningstar.com

• @Christine_benz on Twitter