The good news, for all those who love life, is that every generation has lived longer than the previous generation. This generation of baby boomers will be no different. We will, on average, live longer than any generation that came before.
When the clock struck midnight on December 31, 1899, the average lifespan was less than 50 years. Today, it looks like most of us will live into our 80s. In fact, I happened to be at a speech given by a prominent medical scientist who claimed everyone in the room had a pretty good chance of making it to 100 years old. We are sitting at the doorsteps of so many advances in medical science. Many of the things that used to do us in will simply be cured by the time it’s our time.
The flip side of this ample lifespan is that we have to fund long retirements. It’s no fun being old and broke, so making your money last is a big deal. If you have taken a look at what it takes to produce income from capital over a long period, you know that the three great risks are inflation, outliving your money and losing money.
One of the arguments for stocks in a senior’s portfolio is that you need growth even after you retire. Since inflation takes away half of your money every 20 years, your portfolio will have to double between the age of 60 and 80 just to keep its purchasing power. If you are drawing income from that portfolio at the same time, it usually takes a pretty big return number to make it all work.
As financial planners, we will often encourage a mix of stocks and bonds to reach a higher rate of return.
Let’s say the required rate of return to reach your goal is 7%. A return of 7% should be fairly easy to achieve with a good balanced portfolio. A portfolio of 50% stocks and 50% bonds will normally do the job.
Markets, however, often do not co-operate with our financial projections. While it is true that you might average 7% over a 15-year time frame, you can have pretty wide swings in returns along the way.
The S&P 500 index, an index composed of the 500 largest companies in the U.S., sat at 1,500 at the end of 1999. Today, this same index sits at 1,350. So the 8-year return on this index is negative 10%. If you care to get more depressed, you can consider the appreciation of the Canadian dollar against these U.S. stocks. A Canadian investor in large U.S. stocks has lost over 40% to currency over the same 8-year time frame.
The investor who, in 1999, bought a portfolio of world-beating U.S. stocks as a retirement strategy, and then took 5% per year for income, is likely broke today.
They are broke in spite of the fact that large U.S. stocks averaged 11% per year over the last 200 years.
So how do you avoid this potential pitfall of stock market returns disappearing just when you need them the most? We still need growth in our portfolios to defeat inflation, and we still need a portfolio that will last through retirements that can span 30, even 40 years.
The first step is not to rely on long-term assets, like stocks, to satisfy short-term needs such as income. Stocks become reliable over periods of 10 and 20 years. So whatever income you are going to need over the first 10 years of your retirement should not be in stocks.
One strategy is to take the amount of income you need and put it into a ladder of bonds or GICs. A $50,000 per year income would see you buying 10 bonds that mature at $50,000 per year for the next 10 years.
Once this income stream has been protected, you can now invest the balance, or a reasonable portion of your portfolio, for growth. To increase your safety, you might consider adding some growth investments which are not stocks. Pension funds, for years, have used real estate and private equity to get returns that are as high, or higher, than stocks. Private equity and real estate take their dips like any other equity investment, but the timing of the dips will be different from stocks.
The best retirement portfolio is one that is allocated according to time frame. Your short-term income needs in short-term investments like GICs or bonds. Long-term growth allocated to long-term investments like stocks, private equity and real estate.
Alan MacDonald an Investment Advisor with Richardson GMP Limited, helps investors with over $500,000 of assets make smart decisions about money. Alan is the co-author of "The Copperjar System, Your Blueprint for Financial Fitness" available on Amazon.
All material by Alan MacDonald, Investment Advisor at Richardson GMP Limited. The opinions expressed in this article are the opinions of the author and readers should not assume they reflect the opinions or recommendations of Richardson GMP or its affiliates.
Richardson GMP Limited, Member Canadian Investor Protection Fund. Richardson is a trade-mark of James Richardson & Sons, Limited. GMP is a registered trade-mark of GMP Securities L.P. Both used under license by Richardson GMP Limited.