Finance | BCBusiness
With people living longer and interest rates barely keeping up with inflation, planning to live off of investment income today means looking for alternatives to tried-and-true formulas
When it comes to investing, the traditional asset-allocation rule goes something like this: Start with 100. Subtract your age. That’s the percentage of your portfolio that should be invested in stocks. The balance should go into fixed-income investments. It’s time to rethink that formula in an era of low interest rates and increased life expectancy.
Back in the ’80s and ’90s, bonds paid yields of over 10 per cent. Today they offer returns in the low single digits. In 1979 the Canadian life expectancy 74.9 years; in 2009 It was 84.1. That is great news, but it does bring about the challenge of ensuring that we have enough capital to last our (longer) lifetimes.
For investors, that means portfolios will have to last much longer than they once did, and they’ll have to do so in the low interest-rate environment we’re in for the foreseeable future.
Investors are now forced to nail down a more accurate picture of their income needs, risk tolerance and goals once they stop work to ensure they don’t outlive their capital during retirement. The options boil down to three main choices: reduce their income requirements, increase their risk (allocation to equities) or work past the traditional retirement age of 65 to build a larger nest egg.
Reduce income needs during retirement. This will be a necessity if you accept that less will be available for you to spend when you retire. This could be easy for some retirees, but more difficult for many who planned on entering retirement with a certain amount of cash flow to spend. Anticipating new, lower income needs in retirement starts with a thorough understanding of the investor’s monthly spending requirements and where there’s potential to cut back. Typically cuts come from the discretionary spending pot allocated during retirement and the first priority should be to ensure you don’t carry any non-deductible debt into retirement.
Increase risk in the portfolio. This means allocating more to equities and corporate bonds than you might have originally planned on, or might previously have felt comfortable with. Given the low interest rates, investors, including those who may have relied only on federal and provincial government bonds to fund their retirement income needs, will have to assess alternatives for their portfolios, such as investment-grade corporate bonds, preferred shares and dividend-paying equities to generate income. Investors, and in particular, retirees will now need to take a “total return” approach to investing and meeting income requirements. This approach uses both income (interest and dividends) and capital gains (growth) to supply income. It allows for portfolio growth to provide protection against inflation while using income from bonds and dividend-paying stocks to protect the income stream during volatile periods in the market
Retire later in life. This is one of the most difficult options for those who planned to stop working at a particular age, generally 65. Now they must decide if they must work longer to build a larger nest egg. This requires some psychological adjusting. It may be easy for some who truly enjoyed their careers and got meaning out of them. It may be difficult for those who, for a variety of reasons such as health concerns, may not be able to go back to work or to continue to work past their retirement age.
Any guide to calculating asset allocation should be taken with a grain of salt, taking into consideration individual financial situations and needs, along with lifestyles. Nevertheless, it is clear that demographics and current economic realities require a re-examination of the conventional rules governing asset allocation. Investors and retirees are wise to consult their financial advisors amid these new dynamics to make sure their portfolio mix is right for them, now and for the long term.
Jerry Koonar is vice-president and portfolio manager with Vancouver-based Leith Wheeler Investment Counsel. This article is not intended to provide advice, recommendations or offers to buy or sell any product or service.