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I recently sat down with financial planner Harold
Evensky and Vanguard principal John Ameriks to
discuss strategies for income in retirement. Here are
some highlights.
Benz:
What’s your take on the role of income-
producing securities within retirement portfolios?
What are the pitfalls of anchoring strictly on
income-producing securities and using them to try
to wring your living income from?
Evensky:
My answer is that it results in somewhere
between a bad and catastrophic result. People
need consistent real cash flow, not dividends or in-
terest. And if you design your portfolio based on
[income], that’s going to control the stock/bond allo-
cation, which clearly will have no relationship to
what’s appropriate. So, our approach is you design
a portfolio for total return, then figure out how to
get the cash flow out of it.
Ameriks:
I completely agree with that. And I would
say focusing on income, just as focusing on any single
characteristic, when you’re talking about investing,
if there’s a mistake you can make, it is focusing on
just one thing. Investing is all about making trade-offs,
and the notion that somehow targeting income is
going to be best for someone really, as Harold says,
can be a catastrophe from a lot of different viewpoints.
Evensky:
If you did that today, you’d end up largely
with bonds, and it means when interest rates go up
you’re going to feel rich when in fact the value of
your portfolio is going down. When interest rates go
down, you will feel poorer when your portfolio
value is going up. And then over a time, if you have a
nominal return, inflation is going to eat you alive.
So, other than that, it’s a great strategy.
Benz:
Harold, let’s talk about the bucket strategy that
you use with your clients.
Evensky:
The bucket strategy that I talk about and
use would be called the two-bucket strategy;
it’s a really simple concept. Basically, carve out what
you’re going to need for living expenses for one
year and that goes into liquid investments, basically a
money market account. Set it up to pay yourself a
check once a month like a payroll check. The invest-
ment portfolio is a long-term portfolio and you
manage that very cost- and tax-efficiently. As you’re
managing that at some point you need to rebalance;
if the market collapses, you’re going to sell bonds.
The point is you can control when you’re selling some-
thing as opposed to the market.
Benz:
You take a total-return and opportunistic
approach to refilling that bucket number one.
Whatever has done well—that gets trimmed and
the proceeds go in there.
Evensky:
That’s correct.
Benz:
John, you’ve taken a slightly different spin on
a total-return approach in the managed payout
funds that Vanguard has. Let’s talk about how those
work and how they employ multiple asset classes
to give that total return.
Ameriks:
The strategy itself is built into (our man-
aged payout) funds, so that’s, I think, what makes
it different. But I think the spirit of what we’re trying
to do is very similar to what Harold talks about, and
when talking to folks from Vanguard you’ll hear the
same kind of things—focus on total return, make sure
you have your liquidity needs taken care of, and
then use the cash flows that you are receiving from
elsewhere to tax-efficiently manage a portfolio.
Now, a managed payout strategy can make the task
of rebalancing and maintaining a total-return target or
spending target in one portfolio a little easier. It puts
together a set of funds and a set of exposures at
different risk levels to provide a sort of targeted level
of withdrawals over time. And in looking at the
managed payout funds, an investor has to consider,
”What’s the trade-off I’m making?” Again, I mentioned
trade-offs once before.
Experts Discuss Retirement Strategies
Portfolio Matters
|
Christine Benz
Welcome to our
new feature,
Portfolio Matters,
by Christine Benz, Morning-
star’s director of personal
finance. We’re thrilled to
have Christine help you
manage the portfolio chal-
lenges that you face each
month. Christine will
address personal finance
issues with practical solu-
tions throughout the year.
