Morningstar - Q2 2021 - 58

Investors

down the principal of your fixed-income
investments, and/or sell shares of the equity
investments. Clearly, this is a low point
in what you can receive simply by drawing on
dividends and interest.

A Bigger Base
Rekenthaler: Maybe I'm misinterpreting, but I still think

we're talking about taking principal.

Guyton: It depends on how you define principal.
If a retiree had $1 million a year ago, and
today they have 20% more than that, and they
draw against some of that increase, is that
taking from principal?
Siegel: If we let accountants drive our thinking,
it's not. But an economist would say that
the principal is whatever you have now, and then
the cash flows generated by that principal
would be regarded as income.

to drive the longevity of your investment
portfolio and the lifestyle that you can lead. What
we have now is a market where financial
assets are more expensive than they've ever been.
We don't know what the future is going to
look like, because we've never had a period that
looks like right now.
So, it's hard to project the safety of any type
of withdrawal strategy, and it's also hard
to grasp the impact that such low portfolio returns
will have on lifecycle saving. It means that
we're going to have to save a lot more. We will
live worse because we have to save more,
because income in retirement is going to be more
expensive. It's a depressing message, but
that's what happens when assets become
very expensive.
Siegel: That's why this policy of radically low
interest rates is so upsetting to me. It discourages
savings, yet you need more savings, not

We will live worse because we have
	
to save more ...
Michael Finke

Finke: We just did an article where we looked
at the cost of buying income from 10-year
T-bills and from the S&P 500 in the traditional
sense; that is, dividends and yield on bonds.
Right now, it costs more to generate a
dollar of income from a balanced portfolio as it
ever has in the United States and 3 times
as much as the historical average.

That said, I'm uncomfortable thinking in terms of
income generated from a portfolio, because
I think that distracts us from the most important
aspect of the portfolio: its ability to generate
aftertax returns. That's the only thing that's going

58

Morningstar Q2 2021

less, to generate the same income. It's capital
destruction. When it happened in the
1970s with very sharply negative real interest
rates (although there were high nominal
interest rates), two economists called it financial
repression. That's what we're experiencing
again, but more so.
Guyton: But the other part of the picture
is that people also have quite a bit more wealth
today, depending on how they allocated
their assets, than any reasonable projection would
have made a couple of years ago. It's not all
bad news.

Siegel: Especially if you bought U.S. equities.
Finke: But earnings really haven't gone up
that much. In fact, they've gone down over the
last year. So, you are holding an asset that's
now more expensive than it used to be,
and the expected returns are naturally going to
be lower. Do we celebrate the fact that your
assets are more expensive, or are we cautious
because they are?
Guyton: Or do we take that uncertainty, combined
with a bigger sum total of assets, and say we
can be a little more conservative going forward?
Can we expose ourselves in the future to
less volatility, less uncertainty, and have a greater
amount of fixed assets to weather whatever
storms might be coming?
Rekenthaler: So, someone who's had some exposure
to equities will have a larger pool of assets
than they would have planned on 10 or 15 years ago.
Presumably, they can afford to have a more
conservative withdrawal strategy?

Guyton: Certainly. Say someone who was planning
to retire in 2021 made a reasonable projection
five years ago that their assets would be worth
$1 million and planned to take out $50,000
a year. But now they actually have $1.2 million. It's
a lot safer to take $50,000 out of $1.2 million
than $1 million. Even if future returns are lower,
I'd rather have more money in my pocket
today than not have it and hope that returns will
be higher.
Siegel: The question is, is it more money if
the fecundity of the assets is so much lower that
it produces a lower income? You might prefer
to have less money earning 6% than more money
earning 1%. How that balances depends
on the price of the assets and the interest rate.
Rekenthaler: What might this mean for asset allocation
for, say, a newly retired client in 2021, as opposed
to a new retiree in 2011, when new Treasury yields
were literally 3 times as high as they are now?

Finke: I don't know if it has much of an implication
on asset allocation. If you look at real returns
on safe assets, our best guess based on the market
price of Treasury Inflation-Protected Securities
is that you're going to get about negative 1%. And
Morningstar - Q2 2021

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