Decumulate & Downsize

Most of your investing life you and your adviser (if you have one) are focused on wealth accumulation. But, we tend to forget, eventually the whole idea of this long process of delayed gratification is to actually spend this money! That’s decumulation as opposed to wealth accumulation. This stage may also involve downsizing from larger homes to smaller ones or condos, moving to the country or otherwise simplifying your life and jettisoning possessions that may tie you down.

No surprise: the best retirement investments are the same as for everyone else

We recommend that you base your investing for retirement on a sound financial plan relying on the best retirement investments.

One thing investors of all ages fear is not having a good financial plan in place so they have enough retirement income to live on once they’ve stopped working. Looking for the best retirement investments, addressing this concern is usually a high priority for many of our Successful Investor Portfolio Management clients.

Four key factors to consider when investing for retirement

  1. How much you expect to save prior to retirement;
  2. The return you expect on your savings;
  3. How much of that return you’ll have left after taxes;
  4. How much retirement income you’ll need once you’ve left the workforce.

Our portfolio diversification approach gives you strong potential for long-term gains  

If you diversify as we advise, you improve your chances of making money over long periods, no matter what happens in the market.

For example, manufacturing stocks may suffer if raw-material prices rise, but in that case your Resources stocks will gain. Rising wages can put pressure on manufacturers, but your Consumer stocks should do better as workers spend more.

If borrowers can’t pay back their loans, your Finance stocks will suffer. But high default rates usually lead to lower interest rates, which push up the value of your Utilities stocks.

As part of their portfolio diversification strategy, most investors should have investments in most, if not all, of these five sectors. The proper proportions for you depend on your temperament and circumstances.

For example, conservative or income-seeking investors may want to emphasize utilities and Canadian banks in their portfolio diversification, because of these stocks’ high and generally secure dividends.

More aggressive investors might want to increase their portfolio weightings in Resources or Manufacturing stocks. For example, more aggressive investors could consider holding as much as, say, 25% to 30% of their portfolios in Resources.

However, you’ll want to spread your Resource holdings out among oil and gas, metals and other Resources stocks for diversification and exposure to a number of areas.

Stick with conservative estimates to account for unforeseen setbacks

As for the return you expect from investing for retirement, it’s best to aim low. If you invest in bonds, assume you will earn the current yield; don’t assume you can make money trading in bonds.

Over long periods, the total return on a well-diversified portfolio of high-quality stocks runs to as much as 10%, or around 7.5% after inflation. Aim lower in your retirement planning — 5% a year, say — to allow for unforeseeable problems and setbacks.

Above all, it’s important to remember that while finances are important, the happiest retirees are those who stay busy. You can do that with travel, golf or sailing. But volunteering, or working part-time at something you enjoy, can work just as well. Continue Reading…

Challenging conventional investment wisdom

By Noah Solomon

Special to the Financial Independence Hub

Many investment professionals tell their clients:

  • That markets tend to rise over the long-term.
  • To “hang in there” and “sit tight” during bear markets because they will eventually recover their losses.

While we agree with the first assertion, we wholeheartedly disagree that investors should sit idly through bear markets based on the notion that they will eventually live to see a better day. Rather, we strongly believe that a dynamic approach that adjusts to changing markets can provide superior long-term results.

The table below illustrates this by showing what happens to $1M invested in two different portfolios:

Portfolio A Portfolio B
Year 1 -30% -5%
Year 2 +30% +5%
Year 3 -30% -5%
Year 4 +30% +5%
Sum of returns 0% 0%
Value at end of year 4 $828,100 $995,006

 

Since the returns over four years add up to 0% for both portfolios, many people assume that the final value of each portfolio at the end of year 4 should be $1 million. However, as the last line in the table indicates, this is far from true.

Portfolio A, which is more volatile, declines in value by $171,900, while portfolio B, which is less volatile, suffers a decline of only $4,994.

The observation that two portfolios can have the same sum of returns over 4 years yet have significantly different values at the end of the period can be explained by the mechanics of compounding. After experiencing a 30% loss, a $1 million portfolio is worth only $700,000. Unfortunately, a subsequent 30% gain will only bring the value of the portfolio back to $910,000, which is still $90,000 less that its starting value. However, when a $1 million portfolio experiences a 5% loss, its value is $950,000, and a subsequent gain of 5% will bring its value up to $997,500, which is only $2,500 less than its starting point. Continue Reading…

Retirees can sell most of their stocks as they approach Retirement

By Dale Roberts, for Boomer & Echo

Special to the Financial Independence Hub

Retirement can be a scary time for retirees who have considerable and even modest portfolios. We want to protect those assets. And certainly the risk tolerance level for most retirees will drop considerably. And that risk tolerance level will often drive the bus with respect to your allocation to bonds and cash and other risk management techniques you might put to work.

While the order of returns does not matter considerably in the accumulation stage, when we enter retirement we face that sequence-of-returns risk. Years of poor stock market returns early in the retirement funding stage can permanently impair your portfolio and your retirement. And in fact the risk to retirees begins well before that retirement start date. On Cut The Crap Investing I wrote on that with You Should Protect Your Retirement Portfolio Long Before Your Retirement Start Date. [This also ran subsequently here on the Hub.] Have a read of that article and you’ll see that the Retirement Risk Zone is typically qualified as 5 years before retirement and your first 5 years in retirement. We have to be careful as we approach retirement and in those first few years.

Can a near retiree almost completely de-risk the portfolio and sell a large percentage of their stocks? Sure, it may be emotionally pleasing, but with less stocks in hand it may slightly compromise late accumulation stage portfolio growth. That said, the most important part of it all might be that comfort level and that stress reduction event that comes with greatly lessening that stock component. And let’s face it, some near retirees who’ve planned well and who are lucky enough to have a generous defined pension plan might not need much or any inflation-beating portfolio growth. We’re all snowflakes when it comes to retirement funding, we are all entirely unique in our needs and our situation.

But let’s look at a scenario where a retiree does need their personal portfolio to work very hard; they are counting on that portfolio to deliver a generous component of their ongoing retirement funding needs. It’s time for those hard-earned monies to work for them. On the ‘rule of thumb’ spend rate for portfolios see my Boomer and Echo guest post:  The 4% Rule: Is There A New Normal for Retirees?You’ll read that historically a retiree with a sensible mix of stocks and bonds can spend at the rate 4%-4.5% of the portfolio value each year, with an adjustment or increase each year to compensate for inflation.

Given that we want some growth in the later stages of accumulation and we need that growth component to potentially earn returns above that 5% range, we do not want to abandon that Balanced Portfolio model, we still need those stocks.

To manage the risks, we want to keep that nice mix of Canadian, US and perhaps International stocks to work in concert with that bond component. And the most conservative range that we might move to is 80% to 70% fixed income. That’s a very conservative mix of course.

The returns might be muted but you might be able to eek out 3% income from your fixed income component (a mix of bonds and GICs) and perhaps if stock markets continue to deliver 9-10% annual you must see a returns breakdown such as this:

  • 70% of portfolio @ 3% = 2.1%
  • 30% of portfolio  @ 10% = 3%

That might give you a return in the 5% annual range if the stock market ‘rally’ continues and the bond market does not come under pressure.

Now it’s time to dollar cost average back into stocks

OK, so you’ve largely de-risked but you want and need your portfolio to work as hard as possible. When you hit that retirement date you can begin to increase your stock exposure over time. You might become a retiree stock ‘dollar cost averager’. Yup, you’ll employ the tried and true technique that many of us employ in the accumulation stage: you’re going to add to your stocks on a regular schedule.

You’ve de-risked and then you begin and continue to add risk. They call this an equity glide path. And this has been described and studied in detail by retirement funding rockstars Wade Pfau and Michael Kitces. Here’s their White Paper on the strategy. Continue Reading…

Searching for yield without reaching for risk

 

By Kevin Flanagan, WisdomTree Investments

Special to the Financial Independence Hub

What do almost all major global bond markets have in common thus far in 2019? You guessed it: lower rates. As a result, investors have returned to an environment that could be characterized as “yield challenged” and one that had become all too familiar before last year’s run-up in rates.

Typically, the search for yield comes with added risks as investors either move too far out in duration or lower their credit quality constraints. But what if an investor could enhance yield in their fixed income portfolio while maintaining familiar risk profiles?

Before we focus on a solution, let’s first garner some insights into the Canadian bond market. Similar to the situation south of the border, the Canadian rate outlook going into 2019 was not geared toward a lower rate setting. From a policy perspective, the Bank of Canada (BOC) was projected to continue on its rate hiking path. Prior to the December 2018 U.S. Federal Reserve meeting (the point when expectations began to reveal some change), the implied probability for a BOC rate hike by April was placed around 75% (for those interested, the figure for a rate cut was under 2%). Fast-forward to May 23, and the readings for a rate hike or cut by the end of October are almost split evenly at a little more than 20% each.

CAD 10-Year

CAD 10 Year

How about the Canadian government bond market? As the adjacent graph clearly illustrates, after the 10-Year yield peaked at 2.60% in early October last year, the trend to the downside has been unmistakable. Continue Reading…

How much does it cost to Retire?

By Steve Lowrie, CFA

I’ll start with one good question posed, because it probably crosses everyone’s mind with increased frequency over time:  How much money do I need to retire?

Since I’ve been a financial professional now for more than two decades, I feel well qualified to answer that question.  The answer is:  It depends.

Okay, I realize that isn’t a very helpful answer, even if it’s the truth.  Let’s dig a little deeper.

From a purely quantitative perspective, there are several rules of thumb in common use.  For example, some say if you’ve got 20 or 25 times your annual income in reserve that should do it. Others suggest you’re ready to retire if you can withdraw no more than 4% of your investment portfolio each year.  So, if you have $1 million in your investment accounts, you should plan to withdraw no more than $40,000 annually in a “successful” retirement.

These and similar guidelines offer a decent starting point.  But bad luck happens.  Even if you’ve diligently saved up 20 times your income, if you happened to retire on the eve of a bear market or if you encounter large unexpected expenses, your handy rule of thumb could end up poking you in the eye. Continue Reading…

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