This analyst blog is part of our coverage of the 2018 Morningstar Investment Conference.
If there is one question on investors; minds, it's where to find income, said Morningstar's Jeremy Glaser in the "Show Me the Income" panel at the 30th annual Morningstar Investment Conference in Chicago.
Christine Benz, director of personal finance for Morningstar, said as interest rates rise, higher bond yields have come on-line, and it may be getting easier for retirees to source cash flows through income. For much of the past decade, in contrast, interest rates have been at historic lows, and people were starved for income. As a result, they sought higher yielding assets in unconventional places.
Marta Norton, Morningstar portfolio manager and head of U.S. outcome-based strategies at Morningstar Investment Management LLC, added that rates are indeed ticking up slowly, but from a low level, and valuations are stretched. Some of the places people have found yield in recent years are looking very vulnerable in today's market, she said.
Wyatt Lee, co-portfolio manager of retirement date strategies in the multi-asset division at T. Rowe Price, pointed out that a total return approach and an income approach need to work together as a source of cash flows. When it comes to sourcing cash flows from income versus selling securities, however, investors are hesitant to sell. He points out that investors don’t think about the cost of reinvesting the income, though.
"If you take all of that out, you are losing a lot of capital gains," he said.
Norton agreed, adding that Morningstar Investment Management has done research indicating that the investor outcome with a total return withdrawal strategy is much better than one would achieve by simply collecting income.
"Sometimes the best source of cash flow is hiding in plain sight: appreciated securities," said Benz. She advocates selling appreciated securities as part of a holistic rebalancing process. "If you are an advisor and you're helping clients understand rebalancing, talk them through how you’re improving the risk/reward characteristics of their portfolio."
Glaser asked the panelists if there is there any opportunity left with dividend-paying stocks, particularly after the strong bull run that equities have had since 2008. Norton said she doesn't think U.S. equities are very attractive on an absolute basis, but dividend payers are not any more overvalued relative to other U.S. equities.
"Sometimes investors miss relationships that work in the total portfolio concept," Wyatt said. He pointed out, for instance, that dividend payers are highly correlated with rates, and rising rates put pressures on income-producing assets.
Norton agreed, but added that rate risk is a known quantity that is priced into the assets.
"Our goal is to create portfolios that are durable throughout the market cycle," she said.
Glaser asked for examples of risks to income-producing assets that aren't priced in.
All three panelists mentioned valuation risk. Benz added that she has noticed that many investors have become complacent about equity risk as stocks have performed so well for so long.
The panelists also thought that investors' fears of rising interest rates may be overdone.
"A high-quality intermediate-term and short-term bond fund, as well as some exposure to inflation-protected bonds, make sense for the core of your portfolio," Benz said.
Meanwhile, noncore fixed-income, such as high yield, can make sense for the for the very long-term piece of your portfolio.
"Think of those as long-term assets, like stocks," Benz said.
Wyatt added that global bonds hedged back to the dollar can also be a good choice for core bond exposure. However, despite their usefulness in portfolio building, he has found that many individual investors don't use bonds as core investments.
"They toggle between stocks and cash," he said.
Rounding out the session, the panelists gave their thoughts on annuities.
"Uncertainty is the dark cloud over retirement," Norton said. "Annuities are expensive; it's expensive to have that certainty."
Wyatt added that there are two schools of thought at T. Rowe Price regarding annuities. Some say that annuities are too expensive, while others make the point that if annuities deliver the outcome that you want, in the package that you want, that's a good trade-off that you should be willing to pay for.