Even with retirement on the horizon, our portfolio maintains a sizable equity weighting.
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By Christine Benz | 07-29-16 | 02:00 PM | Email Article

Seventy-five years ago, the average remaining life expectancy for a man reaching age 65 was 12.7 years, and 14.7 years for a 65-year-old woman, according to Social Security Administration data. Fast-forward to today and those numbers have increased to 19.3 years and 21.6 years, respectively

Christine Benz is Morningstar's director of personal finance and author of 30-Minute Money Solutions: A Step-by-Step Guide to Managing Your Finances and the Morningstar Guide to Mutual Funds: 5-Star Strategies for Success. Follow Christine on Twitter: @christine_benz.

Those life expectancy gains are, of course, largely a positive. But when you combine longer life spans with the fact that more and more people are coming into retirement with Social Security as their only guaranteed income source, it's not hard to see why such a large swath of the population is concerned about outliving its assets. In an oft-cited study conducted by Allianz Life Insurance, 82% of people age 44-49 with dependents said that they're more worried about running out of money than they are dying.

Because low bond yields portend meager returns from the asset class in the decades ahead, a very conservative, cash- and bond-heavy portfolio is unlikely to cut it for most retirees. (The sole exception would be the very wealthy, and even they might consider edging out on the risk spectrum to improve their portfolios' return potential for whomever inherits their assets.) To help improve their portfolios' long-term return potential and preserve purchasing power, people closing in on or already in retirement absolutely need to hold a healthy allocation to stocks. That means more short-term volatility, of course, but it also helps reduce shortfall risk. 

That thinking explains why the Conservative Saver portfolio--geared toward still-working individuals who expect to retire in 2020 or thereabouts--maintains a more than 50% weighting in stocks. That's lower than the stock positions in the Moderate and Aggressive Saver portfolios, but it's higher than many pre-retirees might expect. As with the previous two portfolios, I used Morningstar's Lifetime Allocation Indexes to help set the baseline allocations--in this case, the 2020 Lifetime Allocation Index for investors with moderate risk capacities. (I stuck with the moderate index for this portfolio because the conservative index's positioning is simply too meek for most investors, in my view.)

Portfolio Details
For the Conservative Saver portfolio, I targeted a 37% allocation to U.S. stocks, and 14% to overseas stocks. For equity exposure, I held on to the same funds employed in the Moderate Saver portfolio, albeit in smaller allocations. 

Because the bond piece of the Conservative Saver portfolio--44% of total assets--is larger than is the case with the Moderate Saver portfolio, it's also more nuanced. While younger accumulators can get away with a single well-diversified bond fund--say, a core intermediate-term bond fund--people closing in on retirement will want to start diversifying their fixed-income exposure. Thus, the Conservative Saver includes Treasury Inflation-Protected Securities to help preserve purchasing power in the enlarging bond portfolio; I used the low-cost  Vanguard Inflation-Protected Securities

Individuals at this life stage might also start setting up their portfolios by anticipated income needs, as demonstrated with the bucket approach. With retirement five years into the future, it's too early to start raising cash for in-retirement living expenses; at today's very low yields, the opportunity cost of doing so is simply too great. But pre-retirees might consider steering part of their fixed-income sleeves to a short-term bond fund that could be readily converted into cash. After all, having sufficient short-term assets in the portfolio can help mitigate sequencing risk--the chance that a retiree could encounter a lousy market right out of the box. It's not too early to start lining up fairly liquid investments to meet income needs in the early years of retirement--in case income and rebalancing proceeds are insufficient to fund living expenses and the market is in the dumps. 

Morningstar's Lifetime Allocation Indexes also call for a small slice in foreign bonds for investors at this life stage. But in the interest of reducing the number of moving parts in the portfolio, I looked to our core fixed-income fund,  Metropolitan West Total Return Bond , to cover the waterfront. While the fund hasn't historically invested heavily in foreign bonds, I'd rather rely on diversified funds to deliver the noncore exposures than maintain a lot of tiny positions.

10%:  Primecap Odyssey Growth
10%: Vanguard Dividend Appreciation
10%:  Oakmark Fund
7%: Vanguard Extended Market Index
10%: Vanguard Total International Stock Index
4%:  T. Rowe Price International Discovery
30%:  Metropolitan West Total Return Bond
7%: Fidelity Short-Term Bond
7%:  Vanguard Inflation-Protected Securities
5%:  Harbor Commodity Real Return

How to Use
The key goal of all of my model portfolios is to depict sound asset-allocation and portfolio-management principles. Thus, individuals who are closing in on retirement can use the Conservative Saver portfolio to help assess their portfolios' positioning. But it's worth noting that the portfolio won't be a good fit for all pre-retirees. For example, those who will be relying on pensions for much of their in-retirement living expenses, or those who know they can handle the volatility that comes along with a stock-heavy portfolio, will likely want to steer more than half of their portfolios to stocks.

As with the other portfolios, I'll aim to be quite hands-off when it comes to their maintenance. Instead, I'll make changes only when there's a substantive change in the fundamentals of one of the holdings--a significant manager or strategy change, for example.

I also assumed "open architecture" when assembling the portfolios--that is, I assumed that an investor isn't wedded to a single brokerage or fund-company platform. In reality, that's rarely the case, so investors interested in crafting a portfolio along the lines of this one will want to aim for funds that give them similar exposures. (Here again, Morningstar analysts' Medalist funds can come in handy.)

I also developed the portfolios without consideration for tax efficiency--that is, I assumed they would be held inside of a tax-sheltered wrapper of some kind, such as an IRA. Investors who intend to hold their portfolios inside of a taxable account would want to put a greater emphasis on tax efficiency, emphasizing index funds and ETFs on the equity side, for example.

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Christine Benz does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.
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