Learn To Invest
Stocks Special Reports LICs Credit Funds ETFs Tools SMSFs
Video Archive Article Archive
News Stocks Special Reports Funds ETFs Features SMSFs Learn


Retirement planning when you have enough

Christine Benz  |  15 Sep 2020Text size  Decrease  Increase  |  
Email to Friend

One of the most illuminating Portfolio Makeovers that I’ve had the chance to work on over the past few years featured “Ted,” a retiree employing a conservative strategy.  

At age 70 and divorced, Ted was savouring life in a warm climate, spending time with his significant other, enjoying his photography (and making a little bit of money on it, too), and relishing his close bond with his adult daughter. He was extremely frugal—purchasing a small SUV that he expected to keep for many years was a rare splurge. Ted told me that he was content to make do on Social Security and extremely modest portfolio withdrawals of less than 2 per cent. And his portfolio wasn’t huge—about $450,000 in 2018. That translated into a $9,000 annual cash flow from his portfolio, and even less when taxes are taken into account.

Because Ted’s portfolio was so conservatively positioned, with about 70 per cent of assets in cash and bonds, I had some concerns about the effect of inflation on his purchasing power, especially because he noted that his healthcare expenses were beginning to flare up. Thus, my “After” portfolio nudged up his equity weighting to 50 per cent of assets from 30 per cent previously. With a spending rate as low as Ted’s, I argued, he absolutely could afford to take more equity risk; even if his equity holdings encountered a sustained bear market, there was little to no chance he’d need to sell them in a trough. And switching into a more aggressive portfolio mix would probably enlarge his eventual balance, which he could use for travel or pass on to his daughter.

But in hindsight, I wondered if my increase of stocks in the "After" portfolio was more reflexive than it was necessary. Yes, his bond-heavy starting portfolio had low return potential, and yes, a heavier equity allocation would likely bump up returns, albeit with extra volatility. But given Ted’s very modest spending rate, he could afford to maintain a more conservative asset mix that provided him with more peace of mind than he’d be able to have with a more stock-heavy portfolio. His portfolio was enough.

‘If you’ve won the game...’

Ted’s approach reminds me of the saying I most closely associate with asset-allocation guru Bill Bernstein: “If you’ve won the game, quit playing.” The basic idea is that if you’ve built your portfolio up to a point that it meets your goals—as did Ted—you don’t need to keep gunning for additional returns. Instead, you can switch your focus to extracting your cash flows from a more conservatively positioned portfolio that provides you with peace of mind.

Ted’s case is also an illustration that you don’t need to have several million dollars to shift into the “enough/peace of mind” camp. People of more modest means can get there, too. The key is that the portfolio spending rate must be low enough to make it work, and the portfolio should be positioned to support that spending as well as to accommodate inflation and short-term spending shocks.

At the same time, maintaining a very conservative portfolio can introduce risks of its own: Namely, that the portfolio may not grow enough to support the planned spending rate, or that spending could increase due to inflation or a lifestyle shock, such as long-term care expenses later in life. If you’re inclined to de-risk your portfolio for retirement because your spending rate seems low relative to your portfolio size, be sure to consider the following as part of your calculus.

‘Safe assets’: Low return potential poses challenges

Investing Compass
Listen to Morningstar Australia's Investing Compass podcast
Take a deep dive into investing concepts, with practical explanations to help you invest confidently.
Investing Compass

A key consideration for investors attracted to a less volatile portfolio that features lower equity exposure is that the return potential of fixed-income assets has dropped markedly over the past several decades. Current yields are a good predictor of what bonds will return over the next decade, and the 10-year Treasury yield is just 0.70 per cent. Other high-quality bonds yield a bit more, but it’s hard to push yield much over 2 per cent without taking substantially more risk.

That has implications for safe withdrawal rates. After all, the 4 per cent guideline has only been stress-tested over periods featuring much higher yields, and the back-tests featured a balanced equity-bond portfolio, not one that skews heavily toward bonds. That suggests that retirees who wish to maintain very conservative portfolios also need to be similarly conservative about their withdrawal rates. Ted’s 2 per cent withdrawal rate doesn’t seem too far off the mark. The trouble is many retirees won’t find that to be a liveable income stream.

Spending could change

And even as you might have a disciplined spending plan in mind for your retirement, it’s also worth bearing in mind that in-retirement spending isn’t 100 per cent within your control. While inflation has been fairly benign over the past decade, running well below historical norms for most categories, it could run higher in the future. (High government spending to ward off a recession could stoke inflation, though many experts also predicted inflation following the global financial crisis from 2007-09 and it didn’t materialise.) It’s also important to consider that your own inflation experience could be different from CPI at large, especially if healthcare-related costs consume a large share of your spending. Higher inflation has the potential to drive your overall spending—and in turn your withdrawal rate—higher than you intended, even if consumption remains the same.

In addition to inflation, it’s worth considering that what you spend money on—and in turn your total spending rate—might change over your retirement life cycle, too. Research from Morningstar Investment Management’s head of retirement research David Blanchett points to spending tapering down in the middle years of retirement, then flaring up toward the end, largely due to uninsured healthcare costs. If you haven’t made a plan for long-term care expenses should they arise, it’s particularly important to factor in those potential costs.

The value of a second opinion

There are so many moving parts in creating a retirement plan; changes in one part of the plan have repercussions in another. For that reason, it's valuable to get a professional opinion on any asset allocation or withdrawal setup you're contemplating, to understand and troubleshoot any unintended consequences. 

It's also worthwhile to consider all of your spending sources together—not just your portfolio, but also any income you'll derive from Social Security, pensions, or any other sources. After all, if your aim is to create a conservative plan, one of the best ways to ensure that is to create a baseline of retirement cash flows through non-portfolio sources to cover very basic living expenses. That takes pressure off the portfolio and portfolio withdrawals, which in turn can contribute to peace of mind.

Morningstar's Global Best Ideas list is out now. Morningstar Premium subscribers can view the list here.

See also Morningstar Guide to International Investing


is Morningstar's director of personal finance.

© 2022 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'regulated financial advice' under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information, refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Morningstar’s full research reports are the source of any Morningstar Ratings and are available from Morningstar or your adviser. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782. The article is current as at date of publication.

Email To Friend