As baby boomers pile into retirement, strategizing portfolio decumulation and addressing income needs is becoming their chief concern.

Yet new retirees are faced with a retirement industry that’s been focused on the accumulation and preservation of wealth, according to participants in “Show Me the Income,” a Tuesday panel discussion at the 2018 Morningstar Investment Conference in Chicago.

“We all enroll in a 401(k) and more often than not are put into a qualified default investment alternative,” said Wyatt Lee, portfolio manager and vice president at the Baltimore-based T. Rowe Price Group. “We ask, ‘What’s your retirement number?’ We actually need to train people that that should not be the objective. The objective should be the cash-flow stream.”

Lee, who works mostly with institutional intermediaries and 401(k) plan sponsors, said that meeting investors’ cash flow needs and income-paying securities are among the most common topics his clients ask him to address.

Lee said the demand for retirement income investment solutions manifests in two ways: one is in multi-asset solutions that use a blend of dividend payers, bonds and alternatives to generate income for clients, and the other is retirement plan sponsors who have prompted discussions about integrating income products into 401(k)s.

Such products are more common overseas than in the U.S., which has led a large contingent of do-it-yourself investors and a substantial number of advisors to craft income-focused portfolios of their own.

Morningstar’s Christine Benz, director of personal finance, began to focus on income-oriented investing strategies after her father-in-law announced one day that he wanted to fund his entire retirement cash flow needs with his portfolio using concentrated positions in high-yield products.

Benz argued that income-oriented strategies are usually too inflexible.

“There may be times when spending current income is the thing you want to do, but there may also be times where spending through rebalancing is a good idea. I think sourcing cash flows from trimming back positions is a great strategy,” said Benz. “I view the best source of cash flow as hiding in plain sight.”

Morningstar Investment Management, the asset management wing of the firm, has already compared income-focused investment strategies to those that derive cash flows from the total return of a portfolio by both taking yield and selling positions when income is needed, said Marta Norton, the unit's portfolio manager and head of U.S. outcome-based strategies.

Norton said that Morningstar found that both strategies can support a retiree’s income needs, but a total return approach results in higher end balances on average and a higher probability of success.

“Naturally, all of us would not want to sell something if we could just take income from the investment, but what we don’t think about is the cost of doing that,” said Norton. “When the income is the bulk of the return of the security, if you take that money out, you’re losing a lot of the capital returns.”

Currently, many investors are eschewing traditional sources of portfolio income like bonds and annuities for dividend-paying equities, noted the panelists. Growing online communities are dedicated to both dividend yield investing, which tries to create a stable income stream by targeting a stock’s yield, and dividend growth investing, which attempts to capture a growing income stream by finding companies who have the capacity to increase their dividend payments over time.

Both dividend strategies invite more risk into retirement portfolios, according to the panelists. Adding equities into a retirees portfolio increases its sensitivity to market volatility, and concentrates investors into U.S. stocks at a time when valuations are still elevated, said Norton.

Investors also ignore the correlations that dividend payers have to other asset classes, said Lee.

“Dividend payers are highly correlated to interest rates. They’re just as sensitive to rates as bonds, actually,” said Lee. “Overweighting dividend yield around retirement when you already have a slug of fixed income can lead to unintended risks in your portfolio.”

Yet dividend payers are also correlated to value equities, an underperforming area of the market, said Norton. If an investor has a bias to U.S. stocks, dividend payers may actually be a more reasonable place for them to look.

Lee also warned that income-producing investments like dividend payers may encourage complacency.

“A lot of times dividend producers are viewed as safe, but how many retirees bought General Electric because they thought it safe? Then they saw its dividend cut in half,” said Lee. “Without a continual look at the portfolio and what it’s holding, the question becomes whether that dividend is safe. Buying a stock with a high yield usually means the market has already sniffed out that something is wrong with the company.”

If income must be derived from a portfolio holding, the panelists recommended that advisors and investors focus first on a more conventional source of cash flow: fixed income.

Even with some concerns over low yields and rising rates, bonds are still attractive, said Benz.

“We’ve heard so much about how correlations between equity and bond markets have risen, but our data doesn’t support that,” said Benz. “Over the past year, they have declined. Investors may be overdoing their fears of interest rate sensitivity.”

Benz argued that a high-quality, intermediate-term bond fund is a great starting point for a fixed-income portfolio. Investors might want to add inflation-protected securities and short-term bonds to their core allocation, then use their non-core positions for very long-term issues.

Lee recommended international bonds, hedged back to the U.S. dollar, which currently result in yields close to what investors can get in the U.S. Lee also likes short-term TIPS and emerging market corporate bonds.

“I’m not sure that investors get all these pieces,” said Lee. “Investors just don’t do bonds anymore. They toggle between cash and equity because they don’t understand how bonds work, but simplistically they kind of get stocks.”

Annuities, often berated as an income option, should remain in the advisor’s toolkit, said Norton, who added that advisors should be “agnostic” to how a client’s income needs are met because “uncertainty is the dark cloud over retirement.”

Lee agreed, noting that for some investors the income security provided by certain annuities trumps the costs and complicated structures.

“Annuities encompass such a broad basket of products, some don’t have high costs at all,” said Benz, mentioning immediate annuities as a relatively low-cost retirement income option. “A lot of investors have a skull and crossbones on the annuity shelf, but it might be helpful to educate them on how many varieties of annuities there are out there.”

Benz also advocates for a bucket approach to retirement planning, which segments portfolios by time horizon or function. A short-term bucket may hold more cash or short-term debt instruments, while a middle-term bucket would have more intermediate-term fixed income and highly liquid equity investments, and a third long-term bucket concentrated mostly in equities would serve as the growth engine of the portfolio.

Such an approach can help clients think about what constitutes a reasonable allocation to income-generating investments, said Benz.

“It’s a visualization toolkit that I think can be really effective,” she said. “A lot of advisors use it. It helps clients visualize why they’re constructing portfolios like they are.”