The Age When Your Retirement Portfolio Should Shift Gears

Susan Dziubinski: Hi. I’m Susan Dziubinski with Morningstar. I interviewed Morningstar’s director of personal finance and retirement planning, Christine Benz, in early August for a special episode of The Morning Filter podcast. Here’s an excerpt from our conversation.

How Investors Should Position Their US Stock Allocation

Dziubinski: Now, as we’re taping this, the stock market looks, according to Morningstar, about fairly valued right now. Given that, how should investors be thinking about their allocation to US stocks today?

Christine Benz: I always like to bring it back to time horizon. So the age 50 to me is a really neat cutoff point where, if you’re over 50, I think you want to be realistic about derisking a portion of your portfolio. When we look at the data on when people retire, when they think they’ll retire relative to when they actually do retire, we see there’s a disconnect that oftentimes people are thinking they will hang on longer than they are able to do or want to do.

And so I think at age 50 you do want to start derisking your portfolio a little bit. Not altogether because you could have 45 or more years where you are still going to be wanting to grow that portfolio, but as you move into sort of your late 50s, early 60s I like the idea of building a bulwark of safer assets, probably high-quality short- and intermediate-term bonds, little bit of cash. That’s the main avenue I would advise for people at that age cohort. And then for younger people, I think derisking the portfolio isn’t something you should really have on your radar apart from whatever you have in your emergency fund or if you have short-term goals.

But there, I think globally diversifying that portfolio makes a ton of sense where maybe you’re looking at the global market capitalization and using that to guide how much you have in US versus non US stocks. US stocks have definitely been the path of least resistance. They’ve been very easy to own over the past decade-plus. But the global market cap today is roughly, I think it’s like 62% US, 38% non-US. It’s a rare investor who has that much in non-US stocks but I think that’s a pretty good benchmark, and most younger investors are probably underweight in non-US stocks.

Is It Too Late to Invest Internationally?

Dziubinski: Let’s talk a little bit about international stocks because we’ve seen a bit of a revival in international stocks this year, and we’ve gotten questions from listeners to The Morning Filter about this very question, like, “Oh, did I miss the boat? Is it too late to start investing in international stocks?” How would you answer that question?

Benz: Well, first, a little bit of a mea culpa in that I was early in terms of banging the drum for non-US. I was probably doing so three or more years ago. I don’t know. Check the date. I and many other people who look at the market were early in recommending non-US stocks. But we have had a pretty good recovery. Amy Arnott recently wrote a piece looking at whether you’re too late to add international. The short answer is she concluded—probably not—and she pointed to a few key factors.

One is the valuation advantage is still there for non-US stocks. Dividend yields are higher for non-US stocks. She also points to the fact that these cycles have historically run not just a year but several years. The most recent reference point was 2002 through 2007. There were also longer run periods where non-US stocks outperformed US in the ’80s, in the ’90s. So it’s usually not just a one-year cycle and we’re done with it. That’s another reason.

And then, finally, Amy points to the dollar. The declining dollar has been a tailwind for non-US stocks. And if that persists, that will also be gas in the tank for non-US stocks. So a few things I think line up in favor of there still being room to add to non-US exposure today.

What Falling Interest Rates Could Mean for Investors’ Bond Portfolios

Dziubinski: Let’s talk a little bit about bonds. Of course, the market’s expecting that the Federal Reserve will act this year and cut interest rates once or twice. But even so, we’re still in a period of interest rates that are higher than they were for quite a long period of time. So given where interest rates are and even where they might be going through the end of the year, what does that mean for an investor’s bond allocation from your perspective?

Benz: Yeah, it’s very difficult to get investors to enthuse about bonds these days because, let’s face it, when you look at the long-run performance of core bond funds, it’s flat to even negative on a real return basis over the past 10 and 15 years. So there is not a lot to be enthusiastic about from a performance standpoint. But you’re absolutely right, Susan, that starting yields set you up for better returns from bonds going forward. So right now, the 10-year Treasury yield is like 4.2%.

It’s Aug. 6 as we’re taping this, and when we look at the returns from bonds, what we see is that the returns that follow pretty neatly correlate with whatever your starting yields are. And that’s especially true if you sort of build a laddered portfolio of bonds and lock it in. But the fact that bonds have been through a little bit of a dislocation recently actually sets up bond investors for better returns. It also provides a little bit of a buffer if bonds do have losses going forward. If bond prices fall, at least you have that higher yield to help offset those losses. So you shouldn’t have significant principal-related losses, I wouldn’t think.

And then it also just gives policymakers another tool in the toolkit in terms of managing the economy when yields were so low for so long. One of our former colleagues, I remember, described it as: The Fed has a family of four and a blanket for one. Basically, when yields are as low as they are, there’s no room to cut. Well, now that we’re at higher levels, if the Fed does determine that, “Well, it looks like the economy is weakening a little bit more rapidly than we would have hoped,” the Fed has some room to maneuver. So all of those things, I think, line up in favor of bonds. But again, it has been difficult to get investors to be believers, and it’s easy to see why.