With Christine Benz, Personal Finance Editor at Morningstar.com and author of The Morningstar Guide to Mutual Funds: Five Star Strategies for Success
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Steve spoke with Christine Benz, Personal Finance Editor at Morningstar and the author of “Morningstar’s 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”, to get some insights for retirees on how to handle the current low-yield environment.
The Bucket Strategy
Steve started off their conversation by asking Christine straight out how, in such a low-yield environment, people expecting to live off their yield income can manage to get by. He laid out the current situation on yields, saying, “The 10-year Treasury is around 0.6., 0.7%. Short-term CDs are in the 1% range, maybe 2%. So, that probably means, after taxes, losing money to inflation.” Christine replied that “It’s been an ongoing challenge over the past several decades where we’ve had yields on safe investments go lower and lower and lower. That’s left income-oriented retirees with the option of either subsisting on less or gravitating to higher risk, higher income-producing securities. I think that there are other ways to think about building cash flow in retirement that don’t involve exclusively income distribution.”
Steve then asked her to explain what she calls “the bucket strategy.” Christine credits Coral Gables financial planner Harold Evensky as a strong influence in developing the strategy which she explained to listeners: “The basic idea is that you’re kind of structuring your portfolio as a series of buckets. In bucket one, you’ve got cash—CDs, money market accounts, what you have in your checking account, etc. The idea is to have in there two years’ worth of expected withdrawals that you can subsist on when your portfolio isn’t kicking off enough income to meet your living expenses.” She went on to explain bucket two: “Once you’ve developed bucket one, then you’re kind of stepping out on the risk spectrum. With bucket two, you’ve got a portfolio of high quality short and intermediate-term bonds. You’re taking more risks, but you’re potentially picking up a little higher income. The goal is to build yourself a runway with buckets one and two of roughly 10 years’ worth of portfolio withdrawals in safe investments.”
To combat the current extremely low-yield situation, Christine further suggested, “I think you can potentially add some corporate bonds into the mix to potentially pick up a slightly higher yield. You might also think about adding some dividend producing equities.”
Seek Professional Advice
Steve remarked about how much the yield environment has changed over the years. “When I started in the business in 1981, the yields on fixed income were considerably higher than the dividend yields on stocks. But in recent history, that has turned around 180 degrees. We now see a higher yield on the average stock, let’s say 2%+, than we do on US Treasuries and on some corporate bonds as well.” He asked Christine if people can manage to keep up with inflation with a 10-year runway composed mostly of bonds paying less than 2%.
Her advice was to get professional advice, explaining that each individual’s personal financial situation and needs are different. “It’s very personal – run the numbers and see how your retirement portfolio sustainability looks. It may be that 10 years’ worth of cash flows in very safe securities is too much, that you need to step out on the risk spectrum a little bit more. I would definitely get some advice from a financial professional because it’s such an important question.”
Steve concurred, saying, “The idea of having some help here, it’s vitally important. I always say investing is simple, but it is not easy. There are a lot of different variables, different probabilities that you need to take into account. There are a lot of different products out there, some of them great, some not so great, and you really need a guide to navigate that jungle. While I understand the do-it-yourself idea, I think that someone who’s on your side and who does it every single day and has the research to do that is someone that you should seek out. I want to stress that for my listeners—don’t be afraid to get some help and pay some money to get some help. It’s money well spent.”
Social Security—Take it Early or Delay?
Before letting Christine go, Steve asked for her opinion on how people should handle Social Security, as far as electing to take it early or delaying. Christine had, in fact, recently investigated that very subject and found that, as she reported, “In the vast majority of situations, delaying does make sense because of that enlarged benefit you get from delaying. It’s an 8% benefits pick up for every year that you’re able to delay past your full retirement age up until age 70. That’s a big number, and remember that it’s also guaranteed.” But she again stressed that it’s an individual decision and recommended that people review their personal situation with a financial advisor. She added, “There is a free tool called Open Social Security, where you can run some scenarios based on your own Social Security anticipated benefit.”
You can learn more by reading Christine’s articles at Morningstar.com.
Disclosure: The opinions expressed are those of the interviewee and not necessarily of the radio show. Interviewee is not a representative of the radio show. Investing involves risk and investors should carefully consider their own investment objectives and never rely on any single chart, graph or marketing piece to make decisions. Content provided is intended for informational purposes only, is not a recommendation to buy or sell any securities, and should not be considered tax, legal, investment advice. Please contact your tax, legal, financial professional with questions about your specific needs and circumstances. The information contained herein was obtained from sources believed to be reliable, however their accuracy and completeness cannot be guaranteed. All data are driven from publicly available information and has not been independently verified by the radio show.
Steve Pomeranz: I’m very happy to welcome back Christine Benz. Christine is Morningstar’s director of personal finance and the author of 30 Minute Money Solutions, and The Morningstar Guide to Mutual Funds. Christine, welcome back to the show. You are my final interview after 19 years, so thanks for coming.
Christine Benz: Well, Steve, it’s been a tremendous run for you. You’re an amazing host.
Steve Pomeranz: Oh, that’s nice. Thank you so much. Let’s get to business here. What I wanted to speak to you about today was this idea that with yields so low, how is it possible to create a livable income stream for those people who are counting on that?
Christine Benz: Right. It’s a big headache for retirees who might’ve thought well, I’ll just subsist on whatever income distributions my portfolio kicks off. It’s been an ongoing challenge over the past several decades where we’ve had yields on safe investments go lower and lower and lower. And that has left income oriented retirees with the option of either subsisting on less, which very few quite logically want to do, or else gravitating to higher risk, higher income producing securities. So I do think that there are other ways to think about building cashflow in retirement that don’t involve exclusively income distribution.
Steve Pomeranz: Yeah. So if you think of it as cashflow, it opens up some other possibilities. One being that you can use the cash in your portfolio to supplement the low yields for a period of time. So take us through what you like to call the bucket strategy.
Christine Benz: Yeah, this is a strategy that’s really a total return strategy at heart, and I always have to credit Harold Evensky, the great financial planner in Coral Gables, Florida for really influencing my thinking on this. But the basic idea is that you’re kind of structuring your portfolio as a series of buckets. So in bucket one, you’ve got cash. So just CDs, money market accounts, what you have in your checking account, cash investments where you’re not taking any risk. And the idea is that you’ve got two years worth of expected portfolio withdrawals and cash, and you can use those to subsist on in a period when things are really volatile or for whatever reason your portfolio isn’t kicking off enough income to meet your living expenses.
Once you’ve developed that bucket one, you’re kind of stepping out on the risk spectrum. So with bucket two, you’ve got a portfolio of mainly high quality short and intermediate term bonds. You’re taking more risks there, but you’re potentially picking up a little higher income and maybe even a little bit of insulation with this portion of the portfolio, and so you’re building yourself a runway with buckets one and two of roughly 10 years worth of portfolio withdrawals in safe investments. And that way, if Armageddon occurs with the equity market, you won’t have to touch your stock portfolio if stocks are in a trough.
Steve Pomeranz: Yeah.
Christine Benz: That’s the basic idea, and it builds you some flexibility around whatever’s going on with yields currently, you know that you have cash set aside to meet income needs.
Steve Pomeranz: The yields are pretty low. So let’s go through those very quickly. I mean, we’re talking the 10 year treasury is around 0.6., 0.7%. Lending money to the US Treasury for 10 years and only getting that kind of return seems almost impossible. Short term CDs are in the 1% range. Maybe you can get up to 2% going out quite a bit longer. So we’re really not talking much, maybe some inflation coverage, but after taxes, probably not. Probably losing money to inflation
Christine Benz: Potentially so, and I think here you can potentially add some corporate bonds into the mix. I don’t think you’d want to be exclusively corporate bonds, but you could potentially pick up a slightly higher yield by adding some corporate bonds. And certainly if you own a good quality intermediate term bond fund, you’ve got a mix of government issued securities with lower yields and better credit qualities, as well as some corporate bonds with potentially better yields. You might also think about adding some dividend producing equities into the mix, where you can pick up some yield, certainly as well as a little bit of capital appreciation potential, dividend growth potential.
Steve Pomeranz: When I started in the business in 1981, the yields on fixed income were considerably higher than the dividend yields on stocks. That was the norm for 25, 35 years, and in recent history, it has turned 180 degrees over. We now see a higher yield on the average stock, let’s say two plus percent, than we do on US Treasuries and some corporate bonds as well. So you have to have stocks in the portfolio, plus the fact that you have the potentiality of higher dividends throughout the years, where when you buy bonds, those interest rates are fixed. So you’ve got to have, but here’s a question for you, Christine. If I have a runway that carries me 10 years, I mean, that’s an awful lot of bonds in my portfolio at a 2% yield. Is that going to be enough to beat inflation, do you think?
Christine Benz: Well, it’s a good question. I think if you do add some dedicated inflation protection to that portion of the portfolio, you’re hedging inflation risk a little bit there as well. One thing I always say with this idea of a 10 year runway of cash flows set aside, it’s a luxury good. So if you’re someone with a retirement plan that is very, very tight, where if you run the numbers and there’s some risk that you’ll have a shortfall later on, it may be that 10 years’ worth of cash flows in very safe securities is too much. That you in fact do need to step out on the risk spectrum a little bit. It’s very personal, but do run the numbers and see how your retirement portfolio sustainability looks.
And this is a great place to get some advice too. It’s too important, when you’re thinking about will I have enough money in retirement, will my portfolio last. I would definitely get some advice here because it’s such an important question, but the reason I arrive at that 10 way runway, is when you look at the facts, if you have a time horizon of 10 years, it’s actually extraordinarily reliable, that 90% of the time, more than 90% of the time, they’re in positive territory if you have a 10 year time horizon. If you shrink that, the probability goes down, and that’s why I get a little nervous about people running with way less of a cash and bond cushion than what we’ve just talked about.
Steve Pomeranz: No, you’ve made an excellent point. You know, this idea of having some help here, it’s vitally important. You know, investing is simple as I always say, but it is not easy. There are a lot of different variables, different probabilities that you need to take into account. There’s a lot of different products out there, some of them not so great, some of them terrific, and you really need a guide to navigate this jungle and take you through it. So while I do understand the do-it-yourself idea, I think that someone who’s on your side and someone who does it every single day and knows how to navigate and has the research to do that is someone that you should seek out. So I want to stress that for my listeners, don’t be afraid to get some help and pay some money to get some help. It’s money well spent.
Christine, I want to ask you, one major source of income for retirees and pending retirees is social security. And I wondered what the current thinking was in terms of whether one should take it early now with the pandemic or whether one should continue to delay, which is generally the way people, the way advisors have been talking for years.
Christine Benz: Yeah, Steve, I recently investigated this issue because I know it’s top of mind for a lot of retirees. You hear this conventional wisdom about well, delaying is something that always makes sense. And the fact is that in the vast majority of situations, especially if you think you have longevity on your side, or you have a spouse who has longevity on his or her side, oftentimes delaying does make sense because of that enlarged benefit you get from delaying. But I think the real pivotal situation right now is some people have had losses in their portfolios and have kind of wondered, well, if I was planning to retire soon, or maybe I’m already retired and had been planning to delay social security, am I better off invading this depressed portfolio than I am delaying?
And so here’s a spot where I think it makes sense to run the numbers, and there are some good tools out there. One I would recommend is a free tool called Open Social Security, where you can run some scenarios based on your own social security anticipated benefit. But I think that people need to remember that it’ll be probably tough to out earn that benefits pick up that you earn by delaying with any investments in the market.
Steve Pomeranz: What-
Christine Benz: Like I sometimes hear from investors… Oh, go ahead.
Steve Pomeranz: Yeah. So how do you measure his yield pickup you’re talking about? What are you talking about?
Christine Benz: Well, so the number that you often hear is that it’s an 8% return or an 8% benefits pick up for every year that you’re able to delay past your full retirement age up until age 70. That’s a big number, and remember that it’s also guaranteed. So you are not able to get close to 8% with other investment types.
Steve Pomeranz: That are guaranteed too.
Christine Benz: Certainly, other guaranteed. Yes. Right, exactly. Stocks, maybe it will deliver that.
Steve Pomeranz: Yeah, maybe.
Christine Benz: Over very long time horizons, but I’m certainly not guaranteed.
Steve Pomeranz: Yeah, so if you’re comparing apples to apples, if I may, if you’re comparing apples to apples, social security income stream is guaranteed. So you say, well, what are other guaranteed options? Well, I just mentioned the 10 year treasury at three quarters of 1%. Well, look, eight versus three quarters of 1%, it’s better to have eight. So delaying could make sense in that case.
Christine Benz: That’s right. That’s right. So I think making the right comparison is really important and being careful about this idea of trying to out earn your way out of a bear market, I think is a risky proposition.
Steve Pomeranz: Well, Christine, we are out of time, and I thank you so much for all the years of coming on the show, especially sometimes at short notice, and I wish you the best of luck, and stay safe during this difficult period.
Christine Benz: Well, Steve, same to you. It’s been my great pleasure talking to you for all these years. You ask great questions and you do great work.
Steve Pomeranz: Thank you, Christine. Okay, we are out. Beautiful. Thank you, Christine. That was beautiful.
Christine Benz: Okay, thank you so much, Steve.
Steve Pomeranz: Appreciate everything.
Christine Benz: Thank you so much.
Steve Pomeranz: Take care of yourself.
Christine Benz: Well, I do as well, and I hope you have a lot of fun in your retirement.
Steve Pomeranz: Thank you so much. Thank you. Take care.
Christine Benz: Okay, thank you. Take care. Okay.
Steve Pomeranz: Bye-bye.
Christine Benz: Bye-bye.
