As clients age, the decumulation of retirement savings takes center stage. This process begs the question: How can advisors adjust current portfolios, even slightly, to best help older clients?
Christine Benz, Morningstar’s director of personal finance recently reviewed the portfolio of a married couple in their 70s, who mainly live off his Social Security and her teacher pension, as well as a sizable investment portfolio of $1.4 million. They bought their home in the early 1970s for $43,000, and it’s valued at $1.3 million today.
The couple depend on their two income streams, drawing down about $25,000 a year from the portfolio. They’ve wondered if their portfolio, heavily weighted in equities, might need a makeover.
Historically, the portfolio’s makeup has been about 65% equities (47% U.S. stocks and 18% foreign stocks), 33% bonds and 1% cash.
In looking at the portfolio, Benz noted that it’s been tilted toward value (vs. growth) and has been underweight big-cap tech stocks. Plus, it’s favored actively managed funds; for example, two of its largest weightings were positions in the Mairs & Power Growth (MPGFX) and Vanguard Wellington (VWELX) funds.
The fixed income exposure also was “idiosyncratic,” Benz noted. It had high-quality bond exposure via the Vanguard Wellington and Vanguard Wellesley Income (VWINX) funds, but its largest holding was the Pimco Income Fund (PONAX) that “has sizable exposure to higher-yielding lower-quality credits,” she said.
With two income streams and a low level of yearly portfolio drawdowns, “It didn’t make sense for them to hold a huge stake in cash and bonds,” Benz explained.
Her ‘after’ portfolio includes a 41% allocation to these low-returning asset classes, made up of 37% bonds and 4% in cash. This represents a roughly 20% increase in fixed income/cash than the previous holdings, which were 33% bonds and 1% cash, but not a radical tilt toward these holdings.
The equity allocation actually fell to about 58% from 65%, and it’s now weighted 41% U.S. stocks and 17% foreign stocks. Benz noted that the Vanguard Wellesley Income fund does well during equity-market stress, which she kept at its 14.65% of portfolio weighting.
However, she cut the Dodge & Cox Balance fund from the portfolio, she stated, because “its record of capital preservation during equity-market downdrafts is less reliable.”
That said, she added the Dodge & Cox Stock fund (DODGX) with a 5.33% exposure instead “to maintain an allocation to Dodge & Cox’s fine stock-picking approach.”
Also in bonds, she aimed for “the complexion of their fixed-income portfolio to emphasize higher-quality bonds rather than the higher-yielding credit in the Pimco Income Fund.” She felt this would give the portfolio more “ballast in case of an equity market shock.”
To do this, Benz added a total bond market index holding, the Baird Aggregate Bond Fund (BAGSX), to the portfolio with a 13.15% weighting and trimmed exposure to the Pimco bond funds.
A scenario that would mean a higher withdrawal rate from the portfolio is if either the husband or wife were to die, which naturally would eliminate one income stream. The woman’s pension would stop if she passed, and the Social Security payment would end if the man died.
A second issue to consider is if either or both need long-term care.
Benz recommended taking a portion of their portfolio assets and buying a deferred income annuity or an annuity with a long-term-care rider to help defray some LTC costs.
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