It appears to be an overlooked part of retirement planning. While we should always invest within our risk tolerance level we should also match our investment portfolios to the retirement cash flow plan. The plan gives the marching orders for each account. If you create a portfolio-to-plan mismatch, you could increase the risk of depleting an account too soon. On the other side if you are too conservative where an account has the time horizon to run, you create opportunity cost. You missed the opportunity to create significantly more wealth over time.
As always the following is not advice.
We can look to the Canadian asset allocation ETFs for a lesson on risk and asset allocation. In that post that tracks the performance of the asset allocation ETF providers, you’ll find this key table.
We can see that when our time horizon is short we create conservative portfolios with lots of bonds and cash. When we have a longer time horizon of 10 years and more, we can be more aggressive perhaps even holding an all-equity portfolio. But once again, risk tolerance permitting.
I recently discussed risk and common mistakes on the BMO ETF Insights YouTube channel.
In the accumulation stage we might pay attention to this chart if you are saving for a home and plan to buy within the next two years. If would be very risk to hold those home down payment funds in an all equity (XEQT-T) portfolio. Your $100,000 could quickly be turned into $50,000 in a severe bear market.
Sequence of returns risk in retirement
Risk gets flipped in retirement. In the accumulation stage if you have 20 years to go before retirement and we enter a severe bear market, “great”. You can now buy your companies/equities at fire-sale prices. Over time that can generate a boost to your wealth creation. You own more of those great companies.
In retirement, we’re selling shares to create retirement income. When we have to sell considerable shares at lower prices we have to sell (say goodbye) to more of our company ownership. Here’s an example we used in a Retirement Club presentation. Using an ETF as an example, when the price dropped from $30 to $20 we had to sell considerably more shares to create the same income.
If we lose too much of that longterm growth engine (stocks) the retirement cashflow plan and your retirement might be at risk. We need to protect our equities, enough.
The retirement cashflow plan
Every retiree needs to run a retirement cashflow calculator. If you don’t want to go through the learning (very worthwhile) process you can look to an advice-only planner who is a retirement specialist.
At Retirement Club, we’ll show you how to master MayRetire. It is powerful, comprehensive and free-use.
The retirement cashflow plan lays out the spending plan. For typical Canadians it is often based on the three pillars.
A common strategy is to delay CPP and OAS for the much greater government payment benefits. CPP and OAS are pension-like and adjusted for inflation. Here’s an example, if we delay CPP and OAS from age 65 to age 70 the Personal Savings (retirement portfolios) step in to provide the income bridge. The portfolios, often RRSPs and RRIFs, might provide the bulk of the income from age 65 to 70. In some cases we are ‘melting down’ our RRSP/RRIF accounts. For more on that …
The RRSP meltdown. A Canadian retiree’s greatest hack?
Here’s a cashflow example. MayRetire demonstrated that it was beneficial to delay CPP and OAS. The RRSP/RRIF accounts and Taxable account need to do some heavy lifting from age 65 to age 70 to provide the income bridge.
In the above scenario we are creating $120,000 in after-tax income. The couple has almost $2 million in portfolio assets. All of the accounts are in a balanced growth asset allocation, 70% to 80% equities.
The RRSP/RRIF accounts are in red and pink. The joint taxable account is in yellow. If you get a severe crash at the start of your retirement journey, your plan could look like this.
The RRSP / RRIF accounts end up exhausted. The plan is only viable to age 87.
Not surprisingly, the best outcome in a crash-start retirement would be generated by holding the RRSP / RRIF in cash. The plan is funded to age 94.
We can then move the retirement plan to a fully-funded scenario by implementing a varible spend rate inbetween $120,000 to $110,000.
We’ll spend a little bit less in times of extreme bear market stress. For the above plan, we will also get to that fully-funded success rate by moving the RRSP/RRIFs to 80% cash and bonds and 20% equities. Your plan success rate over various market scenarios (Monte Carlo simulations) increases as well, as we have more equities for greater growth over time.
We can also consider a hybrid strategy for the above. We derisk the RRSP / RRIF in the early years to remove or drastically reduce sequence of returns (stock market) risk. We then add equities over time to increase our growth exposure and growth potential. It’s called a reverse equity glide path. Think of it as dollar cost averaging for retirees. 🙂
We go over that in more detail at Retirement Club.
Financial Crisis Meltdown
Here’s a scenario using the real returns from 2007. In 2008 we hit the Financial Crisis. The Conservative Income Portfolio is also 80/20 bonds and cash to equities ratio.
In an extreme RRSP / RRIF meltdown scenario over several years, the conservative portfolio accomplishes its task. It removed the sequence of returns risk. The all-equity model runs out of money. The time horizon was too short. The retiree has the option to protect their portfolio by moving to a very defensive stance.
Of course the defensive portfolio will greatly underperform, if and when we do not face a major correction in the early years of retirement. And based on market history the odds are you won’t face a major correction in year one or year two. But, what if?
Once again, this is not advice. It is up to you how much you choose to ‘roll the dice’ and if you do not pay attention to the account time horizons laid out by the retirement cash flow plan.
Lower the retirement risk by adding annuities
With annuities you are adding guaranteed income for life. Traditional advisors don’t like them, because they don’t get paid. They are not licensed to offer annuities. Ditto for GICs.
Pensionize your nest egg with annuities: your super bonds.
You can add those annuities to your pension-like income bucket. It’s guaranteed income. for life. But of course, they are more akin to an employer pension that is not inflation-adjusted. While you can purchase an inflation-adjusted annuity, that’s not a good route IMHO. The cost (lower income) is not worth it. Grab the higher income annuity and let your equities, gold, commodities, real estate, oil and gas stocks and pipelines work on that inflation risk.
You could also ladder in a 1-5 year GIC portfolio. Check out the current GIC rates at EQ Bank.
Once you have more guaranteed income, you are relying less on your higher-risk investment portfolios. We add those annuity payments to our enhanced CPP and OAS.
Advice-only planners who do often embrace the annuity idea typcially suggest about a 20-30% weighting. It’s only a piece of the puzzle and it ‘always depends’ on the greater plan.
An annuity might not be in the mix early in retirement when an RRSP meltdown is a key strategy.
You might not take on the risk if you don’t need to
If you’ve already won, why keep playing?
The cash flow calculator will show you if a conservative portfolio can get the job done. This might apply accross all of your investment accounts from RRSP / RRIF / LIF / TFSA and Taxable. How much risk do you need for a high probability of cash flow success? But also consider that adding greater risk (more equities) will usually allow you to create a greater financial legacy and greater gifting while your alive. You’ll balance a sensible retirement cash flow plan and your risk tolerance with that ability to gift.
Please feel free to reach out with any questions. Use that Contact Dale button. And please leave your thoughts in the comment sections. Are you factoring in time horizon, sequence risk and your risk tolerance? Did your advisor?
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Here’s Canada’s top-performing Robo Advisor, Justwealth. You can get advice, planning and low-fee ETF portfolios all at one shop. Canadians can have it all. That’s a wonderful shop for retirees who want planning and low-fee portfolios.
Consider Justwealth for RESP accounts. That is THE option in Canada with target date funds that adjust the risk level as the student approaches the College or University start date.
Our savings and GICs
Make your cash work a lot harder at EQ Bank. RRSP and TFSA account rates are at 1.50%, other savings rates up to 2.75%. You’ll find some higher rates on GICs up to 4.00%. They also offer U.S. dollar accounts at 2.75%. We use EQ Bank, they have been awesome.
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We’ll take you through the three pillars of Retirement Club.
Make sure you’re doing retirement right. It’s also suitable for those who are approaching retirement, we need to prepare in advance and understand what we’re ‘getting into’.
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