Hot of the Presses: Morningstar's Head of Investment Research on Returns & the "Retirement Red Zone"

David Blanchett, Morningstar's head of retirement research spoke recently at the Retirement Income Summit here in Chicago. As you know, Morningstar is a respected and reliable source of independent investment analysis. I’m passing along a few of his comments because they have relevance for the newly retired or those planning to retire soon.

(I’ll share my comments in parenthesis)

“Compound stock returns of less than 1% over the next 10 years”.

(So, yes we can assume a few years of negative returns. Maybe more than a few. Those in the “retirement red zone” (just retired or nearing retirement) who have the most to use. For any retirement plan to be realistic, it must include some negative returns in the next 5-10 years.

Online retirement calculators assume a compounded rate of return. If you enter 5%, the calculator assumes 5% one year, then 5% the following year and it compounds these returns to boot.That’s not how it’s going to happen. Compounding only works when there is no risk of principal loss. What’s more likely is that we could see a few years of negative returns over the next 3-5 years. Not saying your portfolio can’t handle it over the long haul; however, we must be cognizant of the possibility.)

“You can’t risk your way out of the current market.”

(This is an important point. Many investors believe they can simply increase their stock exposure when returns are projected to be lower but success in an overall plan has much more to do with timing.)

Much more of your success also depends on when the largest the largest bulk of your assets are invested and when you retire because not all twenty year periods are created equal. If you retired in 2000, you were a happy camper (retiree...) In 1980 or 2008, not so much.)

Mr. Blanchett continues: “As long as advisers use realistic return assumptions, consider reducing portfolio withdrawal rates and continually revise their financial plans, clients can still retire happily.”

(I certainly hope so!)

Is there any action to take:

You know the expression a “rising tide lifts all boats” and that’s certainly been true the last 10 years. Much like investing during the dotcom era when you could essentially pick any unknown, unnamed company that you’d never heard of and it would go up - the last 10 years have been similar. It’s been nice!

However, when the going gets tougher, it changes. Now is the time to consider two strategies.

1) Increase income stability

2) Decrease the risk of principal loss.

Increasing income stability means you create your own personal pension plan. In other words, you position yourself so more of the income you need in retirement comes to you without you thinking about it. This equates to less worry, stress and anxiety.

Decreasing the risk of principal loss means you set a floor under some of your assets. Yes, you do need stock market exposure over time to meet your goals, but it’s not wise that all your money be subject to the whims of the market. As your age increases, it becomes more appropriate to set a floor under some of your assets.

Taking action is not for the “faint of heart” but it is required by those who desire peace-of-mind in retirement!

That’s just the way it works.