Mack: This week on WEALTHTRACK Building a Better retirement portfolio with Christine
Benz, Morningstar's personal finance guru walks us through the process
next on Consuelo. Mack. Wealthtrack. Announcer: Funding provided by ClearBridge
Investments First Eagle Investments, Royce Investment Partners Baird. Matthews Asia Strategas Asset Management and Women
Investing in Security and Education. Mack: Hello and welcome to this edition of
WEALTHTRACK. I'm Consuelo Mack. As we are all well aware, the greatest fear in retirement planning
is not having enough money during retirement. Many guests have told us that it is the biggest
challenge investors face. 2022 didn't help matters any at all. Being well diversified among multiple
asset classes didn't spare anyone from some pain. A particularly troubling case was what happened
to the traditional 60 over 40 benchmark mix of 60% stocks and 40% bonds. 60 over 40 portfolios
had one of their worst years in decades, down 16%. That was the second worst since 2008,
21% loss in the midst of the global financial crisis. The main culprit was the dismal
performance of bonds, which are supposed to offset the risk in stocks. Bonds experienced their
worst year in history. Long term Treasury bonds, for instance, lost nearly 30% of their value. As
the Wall Street Journal's Intelligent investor columnist Jason Zweig put it, Instead of being
balanced for a balanced portfolio, Bonds turned into a torpedo. Well, how can investors protect
the retirement nest egg from future market calamities? This week's guest says there is a
way to build better, more resilient retirement portfolios without being as vulnerable to short
term market behavior. She is widely followed and admired personal finance expert Christine Benz,
Morningstar's director of personal finance, a position she has held since 2008. She writes
daily personal finance columns for Morningstar, does interviews and podcasts, and is the author of
several books, including 30 Minute Money Solutions A Step by Step Guide to Managing Your Finances and
the Morningstar Guide to Mutual Funds. Five Star Strategies for Success. She has also been named
to Barron's list of 100 most influential women in US finance for 2020 and 2021. We are delighted
that Christine is joining us for the fourth year in a row to help us get in personal financial
shape. And this year we are doing a two part series. We need much more help after last year's
market debacle. I asked Christine to describe her bucket investing approach to building
a retirement portfolio. Yes, and I always. Benz: Take care to credit Harold Evensky, who
probably 15 years ago he and I were talking about retirement Decumulation and we were in this period
where yields were very, very low. And the old strategy of subsisting on the income distributions
from your portfolio just wasn't cutting it for a lot of investors. They were having to get into
riskier and riskier portfolios, all in the name of generating that income stream that they were
looking for. So I talked to Harold and said, Well, how do you do it? And his point was that I
maintain a total return portfolio that is balanced across stocks and bonds, but I simply bolt on this
cash bucket. And in a bad market environment like a 2022, for example, we would be pulling from
the cash instead of invading depreciated equity or bond assets. So that's the very simple formula
where you're holding 1 to 2 years worth of your portfolio expenditures in cash. You're not taking
any risk with that portion of the portfolio. Now, of course, you are a little bit vulnerable to
inflation risk given how high inflation has been over the past year, year plus. But the idea
is that you aren't risking any loss of principal, so you're sticking with generally FDIC
insured instruments and using those to fund your cash flow needs. In a bad year,
in better years, you may be pulling from your appreciated equity holdings and using
those to refill that cash bucket and supply your ongoing income distributions. But
in a year like 2022, cash was a savior. Mack: It's interesting that that this
bucket, the cash bucket, bucket one, you need to customize it and it can be
customized to your individual situation. So how do you determine what you need to have
in bucket one, what you need for liquid assets? Benz: Taking a step back and thinking about what
you're all in income needs are in a given year, and ideally you would project this out a bit over
a series of years, and that might ebb and flow a little bit. So I know for many of your viewers
they likely haven't in mind the strategy of delaying Social Security. They've heard the
gospel about why it's valuable to do so. So they may have heavier portfolio withdrawals
coming early. Early on in their retirements, and those might taper off a little bit once Social
Security comes online. So look at this on a year by year basis, but you're starting with your
income needs all in. You're looking at how much of those are going to be supplied by nonportfolio
income sources. And of course, the more of those, the better that you can bring into retirement. If
you're lucky enough to have a pension that you're carrying into retirement, that's certainly good
news because it reduces demands on your portfolio. So you're subtracting out those nonportfolio
income sources from your total income needs, and the amount left over is your anticipated
portfolio withdrawals. That's how much you would hold in cash investments. And then in
terms of the complexion of the cash portfolio, I sometimes hear from investors who say, Oh,
could I hold real estate equities in this portion of the portfolio or short term bonds or
higher yielding bonds? My bias is to really keep it quite plain vanilla, quite safe. And the
good news is that yields are much better now. Mack: The emergency funds, the cash bucket
has really been a difficult investment over the last several years because of zero
yields. And so now we've gotten a real gift for higher interest rates. That's the one
place where we're really benefiting, right? Benz: That's definitely good news for savers
of all types. But still, with inflation, I think you have to recognize that that does erode
the purchasing power of that income stream. Even though yields are better, you're probably
still in negative territory on an inflation adjusted basis, which is the reason why you
don't want to overdo those safe investments, in my opinion, that you probably want to
edge out on the risk spectrum a little bit. Once you've established that cash
flow reserved reserve fund that you'll use to fund your next couple of years worth
of portfolio withdrawals. And then there's. Mack: Bucket two, which again
serves as income withdrawal needs. So describe bucket two and how
it's different from bucket one, right? Benz: This is mainly a high quality bond
bucket. And the way I like to think about it is that I'm kind of stair stepping it
by risk level. So if in some catastrophic environment I've spent through that cash
bucket, there's nothing left in it and I need to figure out where to go for my next
portfolio distribution. I would hold short term bonds. I would hold a component of
short term inflation protected bonds, and I'd also hold intermediate term bonds in
that portion of the portfolio and generally a high quality fixed income portfolio. I like
funds for most investors, mutual funds or exchange traded funds that give them a lot of
diversification in a single shot. But certainly I know that many investors, especially after
the 2022 market environment where we saw bonds and bond funds face serious losses. I know that
many investors are building laddered portfolios of individual bonds. That's a defensible way
to do it as well. I think they just want to make sure that they're adequately diversifying
within those individual fixed income holdings. Mack: And when you're talking about
short term, what are you talking about? Benz: These are typically securities that have a duration of anywhere from 2 to 5 years.
So not super interest rate sensitive. Mack: Can you give us some examples of Morningstar
recommendations that would fit into that, that short to intermediate term kind
of fixed income type of portfolio? Benz: Sure. So Fidelity has a fine fund, fidelity,
short term bond fund. It's pretty plain vanilla. And again, this may be a recurrent theme
as we talk through these ideas. Consuelo, But this is a fund that tends to maintain fairly
high credit quality over time. So that's one we like. Another one would be to use an index
fund. You could use, say, a Vanguard short term bond index that would just take the shorter
term component of the bond market and of course would have very low costs on its side and would
tend to be higher credit quality as well. Another fund that our team likes is Baird short term
bond. We we think they are a superb firm in terms of high quality fixed income exposure
and they run a good short term fund as well. Mack: Bucket three. We'll move right
along to that. And that is really the longest term portion of your investment.
So describe what is in bucket three, ideally and also what purpose that serves, right? Benz: So this is the growth engine of the
portfolio. And from a practical standpoint, if investors have done this work where they're
holding maybe a two year cash reserve and then another eight years worth of portfolio withdrawals
in that bucket two and that high quality fixed income bucket together, that's roughly ten years
worth of portfolio withdrawals. So bucket three would be there for the portfolio's long term
growth. And this is mainly a high quality equity portfolio. I like the idea of globally
diversifying your equities where you're holding a component of US equities certainly, but
also non US equities. And this is where I might also hold other higher risk assets. So to
the extent that I wanted commodities tracking investments in my portfolio or perhaps precious
metals or a REIT fund or individual rights, I would hold them in bucket number three. And the
idea is that over a long time horizon, you should have positive returns on that bucket. So if you
have, say, a ten year time horizon in mind, that should help you make peace with the volatility
that will inevitably accompany that component of the portfolio. But in normal market environments,
it stands to have better returns, better growth potential, albeit with higher volatility
than bucket two and certainly bucket one. Mack: It sounds like it would be broadly
diversified long term growth. As you mentioned, some alternative investments, commodities,
REITs. Can you give us some examples of funds on each of those categories
that Morningstar has highly rated? Benz: We like index funds a lot because of
their low cost. So index funds and exchange traded funds, you could use a total market index
fund and call it a day. You could even use a total world market index fund and really call it a day.
But in terms of individual funds that we like, one strategy that I like a lot for retiree
portfolios is a dividend growth type strategy. So it's not necessarily a strategy where you're
reaching for the highest yields on the market, although I know a lot of retirees do like their
dividend yields. But you're looking for a company that has had a series of dividend increases over a
period of years. So Vanguard runs a couple that we like quite a bit. Vanguard dividend appreciation,
as well as Vanguard dividend growth. T Rowe Price also runs what I think is a really terrific
dividend growth fund, T, Rowe Price dividend growth. And the reason that the dividend growth
strategy I think is so appealing in retirement is that this tends to be a higher quality
subset of the total market. And so we see in a year like 2022, much better performance
on the downside because it excludes some of the more volatile higher tech companies, which
isn't to say I think it makes sense to exclude those companies entirely from your portfolio, but
I think you could shade a little bit more toward higher quality companies and then perhaps
also maintain some total market exposure alongside of that dividend growth strategy.
So you have exposure to the total market, you have exposure to some of those technology
names, but you're shading the equity portfolio a little bit more toward the dividend growth,
the higher quality cut of the total market. Mack: And that's interesting
that you would combine the. Benz: Two investors can kind of think about
their own risk tolerances to guide whether such a strategy is appropriate. One thing I would
say is that if if you really like the idea of taking volatility off the table, you could just
own dividend growth and forget about the total market index. But there will be periods like the
period from 2019 through 2021 where that portfolio is going to look a little bit flat footed because
you're not really participating in some of the highest growth and sometimes more volatile parts
of the market, specifically the technology sector. Mack: What about the alternative
investments that you mentioned? How much of your portfolio would you put in some of
these alternatives like commodities and REITs? Benz: I don't view them as a
must have, I must say Consuelo even though we saw commodities be the rare
category that had really strong returns in 2022, I think that most investors, if they
maintain that cash, high quality bond, broadly diversified equity. Portfolio. They're
getting pretty all weather portfolio right there. I don't see the need to layer on a lot
of alternative assets. And the other reason is that if you really want these assets to
have a meaningful role in your portfolio, you probably would want to own a little bit more
than the 5 or 7 or 3% that investors sometimes kind of tiptoe into them with. So I just don't
see them as essential ingredients, even though they may add a little bit more, a little bit of
diversification in certain market environments. Mack: Among the three buckets, how you would have
adjusted in 2022, what were the kind of moves that you would make that would have protected
you more than the 60 over 40 portfolio did? Benz: Well, the big benefit of a of a
strategy like this is in a year like 2022, you're able to pull from that cash piece.
You're pretty much leaving the bucket two and three alone. But you may want to do a little
bit of rebalancing. And that's one piece of bucket maintenance that comes into play that you may want
to perhaps if you haven't addressed this recently, look at your US versus non US exposure. I
know investors have probably gotten sick of hearing of the benefits of having non US
exposure in their portfolios. Many haven't topped up their non US exposure, but investors
may want to look at that kind of rebalancing. Mack: And before we leave the
60 over 40 portfolio question, you know, it used to be kind of the center of
gravity in a portfolio. The starting point, has it lost its usefulness as a
as a model, a portfolio model? Benz: I think it's still a good starting benchmark
when investors think about building a diversified portfolio. And the key reason is that when
we look over market history in a whole lot of market environments, especially recessionary
environments, we see a really nice pattern where, yes, equities decline and that recessionary
environment, but they hand it off to high quality bonds. And so that's something we saw
during the great financial crisis. We didn't see it so much last year because we had a little
different something going on where rising interest rates were the main thing that were bugging the
market. But in a lot of other market environments, we have seen that nicely diversified pattern.
I do think that holding cash to augment that balanced portfolio makes a lot of sense
for people who are in withdrawal mode. Mack: One of the major changes that we've seen
in the macro economic environment that you mentioned earlier is inflation. So
can you tell us how can we inflation proof or at least protect each of those
buckets from the ravages of inflation? Benz: Really good question. I would say bucket
one, you're not worrying about it so much. The key thing to do there is just not overdo it.
So I mentioned 1 to 2 years worth of portfolio withdrawals. Certainly 3 to 5 years of portfolio
withdrawals is way too high because you'll get eaten alive by inflation. So the main message
with one is just don't overextend yourself by holding too much cash with bucket two. I think
you do want to be thoughtful about making sure you are addressing inflation. That's why I like
the idea of maintaining a stake in Treasury inflation protected securities and or I bonds
I Bonds last year were the hot and sexy asset category. So I like the idea of taking, say,
a third, 25% or a third of that fixed income portfolio and putting it in some combination
of Treasury inflation protected securities and I bonds. I tend to like the short term tips
products. And I think here in exchange traded fund or a mutual fund can make a lot of sense
where you are buying yourself some protection against inflation, but you're not picking up a lot
of interest rate related noise, which is something that we saw with some of the Treasury inflation
protected bond products in 2022. They acted more like bonds than they did inflation protection.
So they had big losses due to rising interest rates. So I like the idea of focusing on short
term tips. The return potential is a bit lower, but I think it is a way to take out some of that
interest rate related volatility with bucket three. I think investors will want to remember
that stocks have had a good long term track record of outrunning inflation. So even though they're
by no means any sort of direct inflation hedge, So in a year like 2022, we saw inflation go way
up, We saw stocks go down. They do not work as any sort of direct year by year hedge. But we
know that when we step back and look at stock returns over long, longer periods of time, they
typically are higher than the inflation rate. Mack: Another cloud hanging over
investors is the possibility of recession. Is there any way to
recession proof these buckets? Benz: Well, I do think that high quality
fixed income portfolio stands to perform pretty well in a recessionary environment.
So think back to the last major recession, the great financial crisis. We saw Treasury
bonds especially really doing their job in that environment, providing that safety
that investors look to in periods like that. So that's what the high quality fixed
income portfolio will do for you in most recessionary environments. We shouldn't expect
too much from our equity portfolios. In fact, we probably should expect some volatility
from them in a recessionary environment. Mack: We mentioned dividend growers,
but we didn't mention dividend paying, current high yielding dividend stocks.
And where would you place those? Benz: Right. And I know many investors
inherently, especially retirees, prefer those types of securities because
they do kick off that stream of income. You could potentially hold a complement of them
in that second bucket to provide your ongoing cash flow needs and to help refill that bucket
number one, as you've depleted it. I like the idea of holding most of the equities, though,
in that bucket. Number three, where you're even if you're emphasizing high dividend yielders
and I think that's a defensible strategy, you would want to give them a nice long time horizon,
a nice long holding period of say, 8 to 10 years. Mack: And if there's one investment
that we should all own in a long. Her diversified portfolio, whichever
bucket you choose to put it in, but it would probably be in bucket three.
What should we all own? Some of Christine? Benz: So one I would call out is a fund called
Vanguard International Value. And the reason I would point to it is that I mentioned many
investors have kind of given up on their international equity exposure. But this one
gives you a little bit of a twofer in that it is focused on non US stocks. It also is focused
on value oriented, non US stocks and of course, value oriented stocks have performed a little bit
better recently, but they've kind of gone through a long, dark night relative to growth. And so it
gives you a little bit of a twofer. You have non us and you also have a value emphasis. And because
it's a Vanguard fund, it is a very low cost, actively managed fund. It's one that I own in my
IRA, one that my husband owns in his IRA as well. Mack: And Christine, what are the top 1 or 2
questions that that all of your Morningstar readers and customers are asking you?
What's uppermost on on their minds? Benz: A couple of things. One is inflation. How
do we think about inflation, manage inflation? We talked about some of the ways to do that.
Another is safe withdrawal rates. What's a safe withdrawal rate from the portfolio? And that's
really the starting point for all of this, is that before you begin your work of figuring
out what's going in each of these buckets and how large they might be, the first step is
to take a look at your portfolio withdrawal, your anticipated portfolio, withdrawal for your
retirement, and just make sure that passes the sniff test of sustainability. Sometimes
people are really confused about what is a safe withdrawal rate. We've all heard about the
4% guideline, which is founded on market history. That's a decent starting point when thinking
about safe withdrawal rates. But older adults, people who have been retired for many years, it's
my view that if they need to, they should take more than 4% from their portfolios because
their time horizons are shorter than that sort of 25 to 30 year anticipated spending
horizon that underpins the 4% guideline. Mack: Christine Benz, thank you so much
for joining us on WEALTHTRACK and helping us build a better retirement portfolio and a
more resilient one. I really appreciate it. Benz: Thank you so much, Consuelo
Always my great pleasure. Mack: At the close of every WEALTHTRACK we try
to give you one suggestion to help you build and protect your wealth over the long term. This
week's Action Point follows Christine Benz lead. It has started adding some international stocks to
your portfolio. International markets have lagged the US for more than a decade since the 2008
global financial crisis. However, that changed last year. Us markets turned sharply lower under
the pressure of high inflation, rising interest rates and recession fears. So far this year, major
international markets are still trading at cheaper valuations. Morningstar recently published
a list of its seven best international stock ETFs. All carry gold analyst ratings, and
among those that generally do not include any US companies are dimensional International
Core Equity Market ETF, iShares Core, MSCI Total International Stock ETF, Vanguard, FTSE ALL-WORLD,
ex-US ETF and Vanguard Total International Stock ETF. As Ben said, gradually adding some
international exposure makes sense, especially in the longer term buckets of your
portfolio. Next week, Ben discusses key retirement blind spots and how to fix them. That's in
part two of our Building A Better Retirement series. In our extra feature, what does Benz do
to recharge from her high powered career? We hope you can follow us on Facebook, Twitter and our
YouTube channel. Thank you for recharging with us. Have a relaxing weekend and make the week
ahead a healthy, profitable and productive one. Announcer: Funding provided by
ClearBridge Investments First Eagle Investments, Royce Investment
Partners Baird. Matthews Asia Strategas Asset Management and Women
Investing in Security and Education. Mack: On the next WEALTHTRACK retirement
blind spots and how to fix them. Morningstar's personal finance guru Christine Benz,
joins us for part two of our Building A Better Retirement Portfolio series. On the
next Consuelo. Mack. Wealthtrack. Hello, I'm Consuelo Mack. Every week on
WEALTHTRACK we sit down with great investors and financial thought leaders to
talk in depth about strategies you need to build and protect your wealth over the long
term. Join us on Consuelo. Mack. Wealthtrack.
