Republished courtesy of the National Post
by Tom Bradley
Baby boomers are a pampered lot. We get all the breaks. While young adults struggle to make ends meet, we pay less on the bus, at the movies and at the drug store on Tuesday. We’re catered to by the media (Golden Oldie radio stations) and the entertainment industry (‘A Star is Born’ remake).
On the investment front, the boomer experience has been nothing short of extraordinary. We’ve had 35 years of declining interest rates which has meant the secure part of our portfolios has not only been secure but also provided a great return (income and capital appreciation). Meanwhile, stocks have done well and our houses have appreciated many times over. Some of us even have defined benefit pensions.
But even so, if you’ve recently retired, or are about to, you’re coming up against a devilish investment challenge. First, you need a regular paycheque from your portfolio. Second, you must avoid large losses because you have limited ability to replenish capital. And the clincher, you need to earn a return in excess of inflation for another 30 years.
No silver bullet
To make matters worse, this trifecta comes at a time when safety is extremely expensive. I’m referring to near-zero interest rates. The days of selling all your stocks and hiding in GICs are gone. This strategy will lose ground to inflation, especially after taxes.
There’s no silver bullet for the silver tsunami — limited downside risk will translate into modest returns.
Before touching on solutions, I should add that the technical aspects of decumulation are also much harder than accumulation. In retirement, you need to pace and structure your withdrawals correctly so you are tax efficient and don’t run out of money.
There are strategies that will help you live more comfortably and confidently in retirement.
They don’t require a seismic shift from your old portfolio, but low interest rates will necessitate some trade-offs.
Investing doesn’t end at 65. Every situation is different, but retirees should have most of their assets invested in a long-term portfolio (40-60 per cent in stocks). They need to protect against inflation and not allow their paycheques to eat too far into capital.
If you’re having trouble getting your mind around this, it’s useful to compartmentalize your needs. Some of your money will be required in the coming five years, some in the next five, but most of your assets will fund spending 10 to 30 years from now. This money should be invested accordingly.
Diversify until you die. Many retirees like to focus on current yield. Everything they own must generate an income. There are real strengths to this approach, but it’s limiting when building a portfolio for the distant future. The pursuit of yield can push investors into overvalued securities which in turn lead to lower returns. As a reminder, valuation is the most reliable predictor of future returns, not yield.
Chasing yield can also lessen quality and diversification. The most troubled stocks on the board often have the highest yields, while the stronger ones are in sectors operating in a narrow part of the domestic economy. There are many good companies in the financial, utility, pipeline and real estate sectors, but owning them exclusively provides little geographic and industry diversification.
Prepare for downdrafts. Owning stocks means your portfolio will dip in value from time to time. This can’t be avoided if you want a return meaningfully above inflation. One way to prepare is to lock down your near-term requirements in a cash reserve which will cover the next one to three years of spending. This allows you to sleep at night and stay the course when markets are weak.
Spending adjustments. I’ll finish where most retirement plans start, with spending. To deal with more volatility, you need to base your discretionary spending on how the portfolio is doing. In other words, renovate the kitchen after a period of above-average returns and postpone the around-the-world trip when they’ve been weak. Building flexibility into your spending is important when the pattern of returns is anything but steady.
Retired investors have a tall task ahead. They’ll have to make trade-offs, pay more attention to the process of harvesting income and perhaps take public transit to shop on Tuesdays.
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