"Safety first is the first step" for retirees with a large chunk of fixed income and cash in their portfolios today, Michael Crook, chief investment officer of Mill Creek Capital Advisors, tells ThinkAdvisor in an interview.
"It's a reasonable expectation that [such investors] are going to lose purchasing power on their cash and fixed income position over at least the next five years, if not the next 10.
"Hold less in fixed income because it's not going to produce much from a return standpoint," recommends Crook, newly promoted from deputy CIO, effective Dec. 31, 2021.
Mill Creek, an RIA based in Conshohocken, Pennsylvania, manages assets of $9 billion for individual and institutional investors.
Portfolios heavy with fixed income "aren't going to grow in value on an inflation-adjusted basis since inflation is somewhat high, but interest rates are very low," says Crook, who has built an impressive career as an investment strategist.
He strongly recommends that retirees hold some "safe assets to provide stability they can count on when they need to spend.
"They need to see if they can get comfortable holding less than 40% in cash and fixed income," says Crook, who joined Mill Creek in 2020 from UBS Wealth Management, where he was head of the investment strategy team.
In the interview, he reveals his strategy of using "a buffer," based on how much fixed income retirees calculate they'll need to spend each year, against a potential market decline and recession.
Crook, earlier an investment strategist with Lehman Brothers and Barclays, then discusses portfolio reallocation and the critical importance of a globally diversified equity portfolio to "help smooth the stream of return over time," he stresses.
He also talks about the private debt portfolio that Mill Creek opened this year to counter inflation and bond yields, which he calls "extraordinarily low."
Private debt portfolios, aka private credit portfolios, "seem to be a kind of increasing trend," he notes.
ThinkAdvisor recently interviewed Crook, speaking by phone from Conshohocken.
In proposing "custom glide paths" for target-date fund investors, he argues that wealthier retirees with a surplus of assets should start taking more risk in a separate "legacy portfolio" once they've passed the "danger period."
That's about 10 years in retirement without experiencing a "disastrous outcome from a market standpoint," he explains.
Here are excerpts from our interview:
THINKADVISOR: What are your thoughts about rising inflation?
MICHAEL CROOK: We're not in anything that could be viewed as a wage-price spiral. Overall, the U.S. economy is basically operating at full capacity.
So all of that excess demand has to show up as inflation since there's no place else for it to go. But over time, it will work itself out.
When do you anticipate that it will start decreasing?
We expect it to probably come down over the next two to three years. If we look out five years, inflation will be much closer to what the Fed expects longer term.
What does that mean to retirement planning now?
For most individuals, it means that they need to really think about the right amount of cash and fixed income they're holding and make sure they're not holding too much.
It's a reasonable expectation that they're going to have negative inflation-adjusted returns — they're going to lose money.
They'll lose purchasing power on their cash and fixed income position over, at least, the next five years, if not the next 10.
So it's a struggle for retirees because for many of them, a large portion of their portfolios are simply not going to grow in value on an inflation-adjusted basis since inflation is somewhat high but interest rates are very low.
How should they position themselves, then?
Safety first is the first step. Retirees need to hold some safe assets, something in their portfolio that provides stability that they can count on when they need to spend.
They need to see if they can get comfortable holding less than 40% in cash and fixed income.
Can you be more specific about how they can offset potentially negative inflation-adjusted returns?
Take time to think how much money — fixed income — they're going to spend each year. That is, figure out how much fixed income they have to hold.
In my view, should be about five years times how much money they spend in a year.
That way, they'll have a buffer if the market declines and we go through a recession. They'll know they'll have five years of spending they can count on.
This creates a buffer that's necessary to offset some of the headwinds — to have that margin of safety built in and know they might have to spend it down if we go through a recession.
Please provide a hypothetical scenario.
If someone is spending 5% of their portfolio per year, they might hold 25% — a reasonable number. If they're a bit cautious, it could be more than that.
But that's the right starting point.
This will be the most important thing they do: Simply hold less in fixed income because it's not going to produce much from a return standpoint.
What's the next step?
Reallocate assets. For most investors, that's going to be an equity portfolio of public equities.
I'm reinforcing the importance of having a globally diversified equity portfolio because it's a risk consideration.
With this portfolio, retirees can reduce the risk of [investing in] individual countries and markets that [can] go through a decadeslong period of not producing any returns.
It doesn't have to be half U.S. and half international. But having, say, 25% or 30% of their equity portfolio outside the U.S. will go a long way in helping to smooth the stream of return over time.
So the reallocation is essentially having less money in fixed income and more in equities? Any "side effects" to that prescription?
By shifting some out of fixed income and into equities, they're going to have a portfolio that's more volatile but at the same time one that has a higher chance of meeting return [needs] over the course of retirement.
Is a globally diversified portfolio a hedge?
