Is It Time for a Retirement Portfolio Reset?

From the standpoint of Christine Benz, Morningstar's director of personal finance, there are still far too many investors approaching retirement with an excess of equities in their portfolio.

This is despite the U.S. and global markets having witnessed one of the most challenging years on record from both a performance and a volume-of-volatility perspective, Benz says in a newly published analysis on Morningstar's website.

It's a difficult but urgent issue she urges financial advisors to tackle head-on in the new year, arguing that the effort to de-risk portfolios in the preretirement years should actually be based on "everything going on financially outside the portfolio."

"Start by thinking about income that you'll get from Social Security or from a pension and use that to determine how much you'll need to withdraw from your portfolio," Benz suggests. "Start by maximizing those nonportfolio income sources. That in turn can help lessen your portfolio withdrawal needs. It's also important to mind the tax consequences of any repositioning, especially if you are lightening up on equity holdings."

Lessons From a Brutal 2022

As Benz notes, 2022 has proven to be a unique year in that equities and bonds have simultaneously performed poorly — something that has only happened a handful of times in the market's sizable history.

That fact leaves a lot of investors who are approaching retirement scratching their heads about what to do now, and about how their portfolios should potentially be repositioned when times improve.

"Historically, when we saw stocks fall in periods of bear markets, we often saw bonds at least hold value or maybe even gain a little bit of value," Benz says. "We didn't see that this time around, in part because interest rates are bugging both stock investors and bond investors. Rapidly rising interest rates depress the value of already existing bonds."

This happens because investors who hold such bonds see how newer bonds are coming online with higher yields attached to them, and they move toward the new bonds instead. That pushes down existing bond prices, in turn.

Speaking directly to those who are approaching retirement in 2023 and finding themselves with a lot of depressed bonds and equities in the portfolio, Benz says the key thing to keep in mind is that this difficult moment is coming on the heels of a prolonged and very powerful bull market that has delivered significant wealth to investors.

"Even though you didn't catch the absolute top in terms of derisking your equity portfolio, you've nonetheless had a really good run in your equity portfolio, most likely," Benz says.

Too Late to Correct?

Still, one can imagine that an investor set to retire in 2023 will be seeking the best place to turn for cash after a tough year for both stocks and bonds.

Sadly, there is not really a great answer for those who have already been burned while sitting in what Benz and others call the retirement red zone — that five- or 10-year window around the retirement date when an investor is most exposed to sequence of returns risk. Very likely, many investors in this position have had to sell stocks or bonds at significantly depressed prices merely to meet their nondiscretionary income needs.

"So, this is just another illustration of why it is important to make sure that your portfolio has adequate liquidity and has adequate allocations to very safe assets that you could draw upon in this type of scenario," Benz says.

For those investors who are really in a pinch and looking to minimize the pain, Benz posits that bonds should theoretically be next in the queue for sale to fund current income needs, because they've performed the least poorly relative to the other asset classes.

And one final tip: "If you need to make changes to get your asset allocation more in line with where you want it to be, concentrate the selling in your tax-sheltered accounts where you won't owe taxes to do that repositioning."