You’re on the right track, but need a more in-depth plan, expert says
The Dow Jones Industrial Average is displayed on a screen after the close of the day’s trading at the New York Stock Exchange. Photo by REUTERS/Andrew Kelly/File Photo By Julie Cazzin and Doug Robinson
Advertisement 2 This advertisement has not loaded yet, but your article continues below.
Q: My wife Evelyn and I, ages 57 and 64, respectively, are retired. We don’t have employer pensions, so are totally dependent on our investments and income from a rental property — about $15,000 net annually. Our withdrawal strategy is as follows: We draw money from our equities when markets are doing well, but we take money from maturing GICs when they are significantly down. Is there a better income-withdrawal strategy? Are we missing something? — Alexander P.
FP Answers: Alexander, one of the biggest risks you and Evelyn face is inflation risk. For years, inflation has not been a big consideration for retirees because it has remained low, so we barely noticed rising prices. But that’s changing, and your investment plan must take it into account.
Advertisement 3 This advertisement has not loaded yet, but your article continues below.
A 30-year time horizon puts Evelyn in her late 80s, a long time span over which inflation can eat away at your savings. Since you have no inflation protection — such as an indexed pension — your investment plan must do that work for you.
Start by considering withdrawal rate risk. Given your ages and the length of time you are likely to be dependent upon your portfolio for income, I suggest you and Evelyn draw between 3.2 per cent and four per cent of your capital as a loose guideline.
One of the risks your question raises is known as sequence of return risk. This means that the order in which you earn your annual returns is a factor we can’t control, yet it makes a huge difference to your outcome.
Here’s a real-life example. The S&P 500 averaged a 4.57-per-cent annual return from January 2000 through December 2020. Intuitively, you would think that if you were invested for all 21 years and withdrew exactly 4.57 per cent of your portfolio each year, you should have the same amount of money as when you started. After all, the markets averaged 4.57 per cent, and you withdrew 4.57 per cent. But that’s not what happens.
Advertisement 4 This advertisement has not loaded yet, but your article continues below.
If you had retired on Jan. 1, 2000, with a $2-million portfolio and started drawing 4.57 per cent of your money each year, you would be down to just over $200,000 after 21 years — and would run out of money sometime during the year 2023.
Your retirement income plan would have failed because the period started with three bad years: annual market losses of 10.14 per cent, 13.04 per cent and 23.37 per cent. Your investments would have substantially fallen in the first three years, and you would have been making withdrawals all the while. Your portfolio would have been cut in half, a hole from which it could never recover.
Now, let’s assume the same period of 21 years, but reverse the order of returns. In this scenario, the last three years are the three negative years I described, but we count the solid returns from 2020, 2019 and 2018 for the first three years. In this case, the $2-million portfolio, 21 years later, would be worth more than $3 million.
Advertisement 5 This advertisement has not loaded yet, but your article continues below.
In the first scenario, which described the real world, you would have earned an average annual return of a little more than 0.5 per cent. However, in the second scenario in which you got lucky and had the same returns in the opposite order, you would have experienced an average annual return of close to 5.85 per cent.
More On This Topic FP Answers: Am I on track to retire in 25 years if I have $350,000 saved now? FP Answers: Am I paying too much in portfolio management fees? FP Answers: Does it ever make sense to take CPP at age 65? This all goes to show that your portfolio and income strategy must consider sequence of return risk. Intuitively, the system you described is attempting to account for bad years, but it needs some fine tuning. You’re on the right track, but need a more in-depth plan.
This advertisement has not loaded yet, but your article continues below.
Article content Here are some points to explore with a retirement planner, so you can clarify what your withdrawal strategy should be going forward. First, ask about using simulated results from what’s called a Monte Carlo analysis. It’s not perfect, so also ask about its limitations. You should also actively adjust your spending annually in the model to reflect investment results. This can be very effective, even though changing spending each year is not desirable for most people.
Many retirees do part-time work during their early retirement years. This reduces strain on the portfolio in the early years if you experience bad results and it helps with the psychological impact of retiring. It’s an option worth considering.
This advertisement has not loaded yet, but your article continues below.
Article content Your investment strategy should reduce volatility to fight against sequencing risk, so ask how the portfolio is specifically constructed to achieve that objective.
Finally, address tax, survivorship and health-care risks as well to ensure you get a more complete picture of the financial possibilities.
Doug Robinson is a certified financial planner and wealth adviser with Veritable Wealth Advisory in Peterborough, Ont., a full-service financial planning and investment firm that employs multiple certified financial planners and portfolio managers with offices in Burlington, Kingston and Peterborough.
_____________________________________________________________
If you like this story sign up for FP Investor Newsletter.
_____________________________________________________________
Financial Post Top Stories Sign up to receive the daily top stories from the Financial Post, a division of Postmedia Network Inc.
By clicking on the sign up button you consent to receive the above newsletter from Postmedia Network Inc. You may unsubscribe any time by clicking on the unsubscribe link at the bottom of our emails. Postmedia Network Inc. | 365 Bloor Street East, Toronto, Ontario, M4W 3L4 | 416-383-2300