Retirees need exposure to stocks

Temporary losses

“People must differentiate between temporary fluctuations in value and permanent loss,” says Darren Coleman, senior vice president and portfolio manager with Coleman Wealth, a unit of Raymond James Ltd. in Toronto. “The stock market correction we saw in August, for example, [was] normal and overdue. It’s like snow in February – corrections are to be expected.”

According to the office of the Chief Actuary of Canada in Ottawa, the average 60-year-old man today is projected to live until just past 85, while a 60-year-old woman will live to almost 88. But, as Clay Gillespie, managing director with Rogers Group Financial Advisors Ltd. in Vancouver, points out, these numbers are merely averages, which means half your clients will live longer – and some will become centenarians. In planning, Gillespie says, clients need to add five to 10 years to those averages.

Anemically low interest rates

“By definition, fixed-income won’t increase to meet rising expenses during the course of retirement,” says Sterling Rempel, certified financial planner (CFP) with Future Values Estate & Financial Planning in Calgary. “A longer life means a longer time horizon, which means clients can better handle a pool of capital that will fluctuate in value but provide better upside over time.”

The current, extended period of anemically low interest rates on traditional fixed-income securities, such as government bonds and guaranteed investment certificates (GICs), restricts their usefulness in retirement portfolios: they should be used for portfolio stabilization primarily, not growth.

Managing risk

Although clients are in need of income in retirement, that income does not have to be generated through interest. Reaping dividends from stocks, selling off a portion of equities at opportune times or setting up regular withdrawals from T-series equity or balanced mutual funds represent alternative ways to realize income from equities.

The old rule of thumb – that the percentage of stocks in a retirement portfolio should equal 100 minus the client’s age -is being adjusted by many advisors to allow for higher exposure to equities.

“The juice is simply not worth the squeeze in fixed-income,” says Coleman. “The traditional rule that a 70-year-old needs 70% in fixed-income is now being flipped on its head.”

Coleman says his clients’ portfolios are more likely to have fixed-income allocations of 10%-30%, depending upon the client’s financial resources, expenses and risk appetite. To manage risk, Coleman takes a “barbell” approach to client portfolios: holding more equities at one end and more cash at the other, with less fixed-income in between. Cash allocations range from 10% to 15% and, although cash has no growth potential, it can be a source of income for retirees in years when equities are down.

Many advisors, including Coleman and Gillespie, advise putting enough cash away in “safety buckets” to supply three years of income for a client in retirement. For example, Gillespie, who typically recommends a withdrawal rate in the initial stages of retirement of up to 5.5%, advises putting one year’s income in a money-market account for the first year; one year’s income in a one-year bond or GIC for the next year; and one year’s income in a two-year bond or GIC for the third year. The balance would be invested in a growth portfolio based on the individual client’s situation.

Staggered GICs

The rationale behind this strategy is that the money-market account will be depleted during the first year. After that first year, if the equities portion of the portfolio has increased in value through capital gains and dividends, that growth can be used to replenish the investment in the money-market fund.

If, however, the stock market declines and the growth account shrinks in value as a result, the client can use the maturing GIC to replenish the money-market account. If the GIC is not used for the current year’s income, it will be reinvested for a new guaranteed period of two years to create a staggered situation in which a two-year GIC matures every year.

Avoiding forced selling

Unless there is a stock market decline that lasts more than three years, your clients shouldn’t be forced to sell off investments that have lost value. Clients will have enough cash-like investments to weather the storm, and the buckets can be replenished when markets recover.

Although past history is no guarantee, the collapse of the high-tech bubble that began in 2000 lasted 30 months from top to bottom on the S&P 500 composite index, while the drop triggered by the financial crisis of 2008-09 lasted 17 months from top to bottom. Despite many market downturns, the S&P/TSX total return index had an average annual return of 8.2% for the 30 years ended Aug. 30, 2015.

Clients generally are able to accept more fluctuation in the equities portion of their portfolios when their near-term income needs are provided for, Gillespie says, and clients also are more likely to stick to their targeted asset allocations in turbulent markets.

Other strategies you can use to keep your clients committed to the important growth-providing equities in their portfolios include using low-volatility exchange-traded funds or mutual funds, or funds that employ options strategies to add a bear market hedge. Some mutual funds, such as the Enhanced funds family sponsored by Sprott Inc. and the Ivy fund family sponsored by Mackenzie Financial Corp., both of Toronto, are managed defensively for a smoother ride.

Client psychology

Other strategies include the use of products with guarantees on assets or income, such as segregated funds or guaranteed minimum withdrawal benefit products offered by insurance companies. Most of these products offer upside potential and the opportunity to lock in gains regularly. Although some of these products may lag the market due to higher fees, many clients prefer to forgo a bit of portfolio return in exchange for piece of mind, says Bill Bell, CFP and president of Bell Financial Inc. in Aurora, Ont.

He says seg funds can be an attractive investment for clients who might otherwise cling to the security of GICs with no hope of making a decent return; seg funds can act as “training wheels” for stocks.

“The higher management fee may be worth it,” Bell says, “if the goal is to turn some GIC holdings into equity. If a GIC is paying 2.5% a year and you can get 4% in a seg fund after fees, the seg fund starts to look more palatable.

“A lot of what an advisor does for clients relates to psychology and behaviour,” he continues, “to help them feel comfortable and stay on course.”

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