With middling forecasts for many investment vehicle returns in the next decade, it might be time for advisors to review the implications for clients at or near retirement.
Christine Benz, Morningstar’s director of personal finance, outlines four factors advisors should keep in mind for retirement plans during this rocky investment period.
In What High(ish) Equity Valuations Mean for Your Retirement Plan, Benz focuses on equity valuations, which in mid-October were at around 32 on the cyclically adjusted Shiller P/E ratio. She writes this level was “exactly double its historic median and even higher than it was in the late 1990s.”
Poor fixed-income returns and a rocky equity market may have these implications for soon-to-be and new retirees, she says:
1. Asset Allocation and Glide Path
The typical investment glide path of an in-retirement portfolio starts with more aggressive vehicles and moves to safer assets, but that might not work in a world of high equity valuations, Benz notes.
In fact “lofty equity valuations make a good case for retirees starting out with a lower equity weighting,” Benz says, and by “starting out with more conservative portfolios, new retirees have a buffer of safe, nonequity assets that they can spend through as retirement progresses.”
This is the “reverse glide path” idea from Michael Kitces and Wade Pfau, which she points out is similar to a bucket strategy that allows retirees to rely on cash and bonds if stocks slide.
“If the stock market continues to perform well, the new retiree can subsist, at least in part, on the appreciation from equity holdings,” she writes. “But if stocks slide, as high valuations suggest they could at some point, the retiree can use cash and bond holdings to meet living expenses.”
Caveat emptor: Cash and bond returns are low or even negative today, and may be for a long time, so don’t “overallocate” to safe assets, she warns. Also, look at “buffer” assets such as reverse mortgages and life insurance cash value.
2. Intra-Asset-Class Positioning
Right now, Benz points out, the current U.S. bull market is dominated by a handful of names with “relative underperformance” of the rest. Hence, retirees and their advisors must look inside the portfolio as much of the overvaluation is being driven by a few mega-cap stocks, she says.