Throughout our working years, through a combination of savings, debt-reduction, and prudent investment strategies, we focus on growing our net worth. How successful we are varies with the degree of discipline we apply to these efforts.
While important to a secure and comfortable retirement, this effort is not nearly as critical, once we reach retirement, as then preserving whatever amount of capital we have accumulated.
We need to ensure that we do not outlive investments.
How do we achieve this major shift in focus?
We need to ensure that we limit our draws from investments to a reasonable percentage of the account’s value. Many suggest that for a 65 year old, a four per cent annual withdrawal rate will eliminate the concern of exhausting capital before age 90.
While this may be a safe percentage, it is not necessarily the best choice.
A better determinant of a safe withdrawal percentage is to begin by first examining the Net Income (yield) contribution to the portfolio’s growth. If assured, for example, of 3.5 per cent annual yield, a four per cent draw would consume only an insignificant 0.5 per cent of capital.
On the other hand, were the annual yield only one per cent after all holding costs, a four per cent draw may be too aggressive.
As usual, no single number or formula can be applied to all investors.
Historically, another means of moderating portfolio risk has been the selection of a prudent asset class allocation between Equities and Fixed Income products. In the past, many investors followed the consensus opinion of choosing a fixed income percentage matching their age – at age 65, the investor might have held only 35 per cent in Equities; 65 per cent in Fixed Income.
Today, these past truisms are not only obsolete, but may actually increase an investor’s risk. Bonds and bond funds, for decades the “safe” inclusion in Fixed Income, are no longer a natural hedge against a falling Equity market.
With record-low interest rates, it can be argued that high bond holdings can actually represent a greater risk than Equity markets; as rates increase (which they are), portfolio bond values decline. Limiting the term-to-maturity of bond holdings to less than five years minimizes this risk.
Perhaps the safest holding of bond products is one-to-five year laddered bonds, resulting in an average 2.5 year term to maturity.
Today, carefully-selected dividend-paying Exchange-Traded Funds (ETFs) for example, will deliver a much higher income stream to a portfolio than will bond products. Hence, a greater mix of equity-based investments may well be the safer alternative to conventional bond-oriented wisdom.
Another solid strategy for retirees is to take advantage of the strong historical fact that for over 60 years, the twelve Canadian Equity Bull Markets have lasted on average, 50 months, gaining an average 124 per cent; an equal number of negative (Bear) markets have lasted on average, only nine months, with an average decline of 28 per cent. Clearly, the longer one holds a prudent selection of Equity holdings, the greater the probability of excellent returns, and the lower the risk of losing capital value.
How can this compelling statistic work for retirees?
A simple technique for example, could be to purchase a 1-5 year laddered Bond ETF, sufficient to meet the retiree’s annual draws for the following three or more years. Should Equity markets decline in any of those years, the investor would not be forced to sell equity holdings at a loss to cover necessary withdrawals. Essentially, the equity component of the portfolio becomes immune to shorter-term downturns of Equity markets.
These are only a few of the techniques which can help ensure the retiree does not outlive investments.
Once we accept the fact that we cannot predict the periodic gyrations of Equity markets, and instead turn our attention to controlling manageable risks, we will not only do a better job of preserving capital, but also sleep better.
As always, whether employed or retired, we have absolute control of a number of key strategies to reduce investment risk:
. Minimize annual holding costs of our portfolios;
. Optimize the income stream (yield);
. Select a prudent asset class mix;
. Achieve significant sector and geographic diversification; and
. Recognize that our investment time-frame is many years, even decades long.
While important for investors at any age, focusing on strategies which limit manageable risks during retirement years becomes absolutely crucial.
A retired corporate executive, enjoying post-retirement as an independent Financial Consultant (www.dolezalconsultants.ca), Peter Dolezal is the author of three books, including his Second Edition of The SMART CANADIAN WEALTH-
BUILDER.