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.

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…

You should protect your retirement portfolio assets long before your actual retirement date.

By Dale Roberts

Special to the Financial Independence Hub

We often think of wealth building and retirement as static dates. We have that accumulation stage when we are building our assets and net worth, and then we have that decumulation stage (retirement or semi retirement) when we are spending our assets. We tend to think of those periods in static terms, with hard stop and start dates. But that could be dangerous thinking thanks to what Dr. Moshe Milevsky of York University describes as the Retirement Risk Zone. That period is typically 5 years before your retirement date and the first 5 years of retirement. That is when the risks are greatest for a retiree.

We need to prepare our investment portfolios well in advance of our planned retirement date. We need to protect our ASSets. And certainly we build wealth in many ways or by many channels. We have our cash and investment portfolios, and we may also have workplace pensions that are building future retirement payments. And of course we have our real estate and perhaps we are also building value and net worth in business ventures. We may have inheritances that we know are likely to come our way. On that front, we don’t want to count those chickens before they hatch.

In this post we’ll discuss protecting the assets that potentially hold the greatest risk: the stocks in your investment portfolios. Of course the funds could be in an RRSP, RRIF, a locked-in plan of sorts, your TFSA or in taxable accounts. And the risk comes from holding those stocks that can be more than volatile at times.

As a refresher, imagine if you had picked January 2008 as your retirement date. In 2007 things are looking rosy and then the Financial Crisis hits and the US stock markets fall by more than 50%. The chart is courtesy of portfoliovisualizer.com

Retirement 2008 start dateYour handsome $350,000 RRSP portfolio gets clipped to fall below $200,000. If a retiree was spending down in typical fashion on the above portfolio they would have seen that $350,000 drop to the $170,000 range. If one entered retirement with an aggressive all-stock stance, they might have their retirement permanently impaired. The Retirement Risk Zone is more about the retirement funding math compared to your tolerance for risk.

Related post: How Retirees Made It Through The Last Two Recessions

When should you prepare your portfolio for retirement?

Again, Dr. Milevsky suggests the risks are great even 5 years before retirement. I’ll give an example using perhaps the most dangerous start date for a retiree over the last 50 years: the year 2000. This was the beginning of a stock market correction that simply would not let up. US stocks were down for 3 successive years in 2000, 2001 and 2002. That has only happened twice in US stock market history, you’ll have to go back to the Great Depression of the 1920s and 1930s to find the other event. Canadian stocks were down for 2 years in a row and did not suffer the same level of meltdown (though it was certainly a troubling bear market).

As you can imagine if a retiree had the year 2000 as a retirement start date and they entered retirement with an all stock portfolio that asset bucket would have been permanently impaired. Of course, I’m assuming that they need to spend from that account type. If you need to spend from that plan or retirement bucket, you need to protect those assets at least 5 years in advance.

Here’s an example of failure in the last years of portfolio accumulation for a retiree. The year is 1998, the stock markets are one the greatest kicks in stock market history and our retiree is smiling from ear to ear with those incredible portfolio gains and a planned 2003 retirement date.

In 1998 our future retiree has $350,000 in her RRSP account, she is still adding $700 monthly, or $8,400 annual. Once again, we’ll use the US stock market for demonstration purposes. Of course you hold a more diversified asset mix.

Retirement 2003 No ProtectionThe retiree has been adding monies on a regular schedule for 5 years and has a negative rate of return. The real rate of return when we factor in inflation is even less favourable. The retiree started 1998 with $350,000, added $42,000 and ended the period with just over $369,000.

In Scenario 2 our retiree moves to a Balanced Growth model in 1998. She is now 70% stocks and 30% bonds (I’ve used 10 year treasuries). She enters 2003 with modest but positive returns for the period, and with a portfolio value of $438,000.

Retirement 2003 with ProtectionAnd of course, to a point, the more conservative a portfolio (more bonds) the better for the test. But hey, that’s all certainly hindsight as we’ve picked the worst possible retirement start date. Right? Not so fast. Even if we look at the 2008 market correction protecting the assets well in advance works much better, and the more conservative the balanced portfolio, the better. You might at least keep your equity allocation in the 30%-40% area.

*And certainly, one can use other assets beyond bonds to manage risks.

We are on the same last few years accumulation strategy with a 2010 retirement start date. In this example we are ‘protecting’ the funds 6 years in advance.

Portfolio 1 is all US 100% equity.

Portfolio 2 is 60% stocks and 40% bonds.

Portfolio 3 is 40% stocks and 60% bonds.

Retirement 2010 start date various allocationsThe only time this strategy will fail, that is deliver opportunity cost, is when we take out a severe market correction and invest only in a period of mostly rising markets (bull markets). Of course as an investor or advisor that is not a risk that you want to take. You do not want to guess that a stock market correction is not in the near future. Stock market corrections historically come along with regularity. We are currently in an abnormal period of an extended (mostly) bull market run.

A more conservative accumulation stage

As we approach the final turn toward the retirement ‘finish line’ we obviously want to increase our portfolio value. Continue Reading…

My biggest retirement planning mistakes

Looking back, my biggest retirement-planning mistakes had nothing to do with money. Rather, they resulted from not thinking things through and not having a good retirement lifestyle plan in place, for when I did retire.

Because of that, it took me a couple of years to figure things out and get things right after retiring. Unfortunately, I will never get that time back. If I could do things differently, here are some of the mistakes that I would avoid making:

Mistake #1

Deciding to turtle, play safe and hang on for another 7 years

The opportunity cost of staying in a career that you no longer like just so you can max out your pension is high, especially if you have already achieved financial independence. You end up losing precious time and become sour. But there is something about that pension statement with the pre-determined retirement date that keeps us coming back for more. I can’t tell you how much time I spent running the numbers over and over again trying to figure out the right combination that would allow me to move on to something better.

Few people quit a marathon at mile 25 and most people late in their careers will choose to hang in there until the bitter end. But they need to ask themselves: Is it really worth it?

Why continue to waste valuable time putting off something that you are truly passionate about?

Although switching to part-time work means taking a pay cut, finding great work increases the odds of you working longer. Instead of retiring at age 62 feeling tired and worn out, you are thriving and excited by the work you do. By finally making the choice to leave and start your Victory Lap (VL), you no longer go to bed at night dreading the next morning’s work, trying to hang on until another weekend. Making a little less for a little longer while dramatically increasing your daily personal fulfillment is a total win.

Mistake #2

Not knowing my values and what would make me happy in retirement

I’ve learned that a great retirement is not about how much money I have; rather, it’s about an attitude, a way of living, filled with searching and discovery. To have a great retirement, you need to have a good sense of who you are, what you are, what you value and what will make you happy.

Unfortunately, because we are so busy taking care of our families and just trying to survive, we lose touch with our values.

In order to be happy in retirement, you need to get a good feel for who you are. This can be done through self-analysis to identify your abilities, values, drivers and interests. After going through this process, you will know what you are good at, and what you want/need to do with the rest of your life.

Mistake #3

Not starting work on my side gig before I left my corporate job

Working on what I planned on doing in my VL would have been a far better use of my time, instead of wasting it de-stressing in front of the TV for hours at night. Continue Reading…

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