Your clients may stop working at retirement, but that\u2019s when their investment portfolios enter their hardest-working years. Facing a retirement that could last more than 25 years, clients have to count on continued growth from their portfolios if they are not going to outlive their money. That means challenging the traditional assumption that senior retirees should hide out in fixed-income securities.
Research by Seattle-based Russell Investment Group, <\/b> a subsidiary of Northwestern Mutual Life Insurance Co., shows that the bulk of retirement income can actually come from growth that takes place after the client has retired. The Russell report calls it the \u201c10\/30\/60 rule\u201d: 10% of retirement income can come from savings during the working years, 30% from growth on those savings during the working years and 60% from growth after retirement.
Surprisingly, the asset mix required to achieve these growth rates is a relatively conservative mix of 65% fixed-income and 35% equities, which the Russell report calculates should produce an average annual return of 7%; equities should produce 9% a year and 6% a year should come from fixed-income.
Russell\u2019s research assumes continuous contributions to the retirement-savings portfolio and growth throughout the working years between the ages of 25 and 65, followed by a 6% withdrawal rate in the first year of retirement, with the dollar amount of the withdrawals increasing at an annual rate of 3% to compensate for inflation. The withdrawal rate is set to leave the account at zero upon death at age 90.
\u201cThere is a common misconception among investors that savings are the primary driver of their retirement income,\u201d says Frederick Pinto, managing director of distribution services with Russell Investments Canada Ltd.<\/b> in Toronto. \u201cIt would be wrong to conclude that saving isn\u2019t important, as without the contributions, there can be no investment return. But most people are surprised to learn that with a sound investment program, the bulk of the growth can take place after retirement.\u201d
Investors wrongly think 50% of their retirement income comes from savings, 30% from growth during their working years and 20% from growth after retirement, Pinto says. In fact, Russell\u2019s research shows, only 10% of retirement income comes from savings and a whopping 90% from growth.
When it comes to designing an effective retirement portfolio, Pinto says, the two big risks are downside stock market volatility and the client\u2019s longevity risk. According to Russell\u2019s research, a relatively conservative mix of 35% equities and 65% bonds can earn the growth and long-lasting income that clients need, with manageable volatility. Alternatively, a conservative portfolio of 100% fixed-income was once considered the traditional portfolio for retirees, providing little in the way of long-term growth and unlikely to last through today\u2019s lengthy retirement years.
The Russell report assumes a 25-year retirement, which means a person retiring at 65 will see their money last until age 90. But if markets underperform historical averages, or if the client lives longer, there still is a risk of running out of money. The commonly used \u201crule of 20,\u201d says that for every $1 of pre-tax income desired in retirement, a client should save $20, which means a $50,000 income would require a $1 million portfolio, and a $30,000 income would require $600,000. A client wishing to provide a buffer for these assumptions could use a multiplier of 25, meaning an income of $50,000 requires a portfolio of $1.25 million at the outset of retirement, or a $30,000 income requires $750,000.@page_break@Or clients can make other changes, such as delaying retirement, taking part-time work in retirement, making smaller withdrawals or investing in a more aggressive asset mix.
Paul Delfino, financial advisor with Scotia-McLeod Inc. <\/b> in Kanata, Ont., has developed a program called Financial Peace of Mind that educates his clients about the need for growth in retirement. He says that with an average retirement age for his clients of 62, and current trends indicating that at least one spouse in a couple that age now will make it to age 90, growth securities in a portfolio are essential. Traditional GICs and bonds have yields of 3% or lower in today\u2019s market, which provides hardly anything after inflation and taxes.
Delfino helps his clients define their minimum annual retirement income, then he sets aside enough in cash and short-term investments to provide three years\u2019 income. This safe capital is the \u201cbomb shelter\u201d; it\u2019s meant to help a portfolio withstand rough periods in the markets, like those of 2008 and 2009, so that the client isn\u2019t forced to sell equities in severe bear markets. The rest of the client\u2019s capital is invested in diversified blue-chip equity funds, giving the client access to the growth and dividends from companies from around the world.
\u201cInvestor behaviour, not market behaviour, is the biggest determinant of investor success,\u201d Delfino says. \u201cInvestors may be in the right things, but if they sell at the wrong time, it can be devastating for a portfolio.\u201d
In normal times, Delfino\u2019s clients withdraw income from their equities by selling off their mutual fund holdings on a systematic basis and reaping income from dividend-paying stocks. On a $1-million portfolio, if the client requires a bare minimum income of $50,000 a year, that would mean $150,000, or 15%, would be set aside in the bomb shelter, and up to 85% would be invested in equity mutual funds. Clients with other sources of income, or those who continue to work part-time, would need a smaller bomb shelter. Says Delfino: \u201cThe bomb shelter is there to give clients confidence in times of turmoil, so they don\u2019t sell equities during a severe downturn.\u201d
Concepts such as \u201csafety\u201d and \u201crisk\u201d must be evaluated, as the volatility in equities is often mistaken for risk, says Delfino. Longevity risk and the risk of declining purchasing power due to inflation are less obvious but potentially more dangerous than the volatility of stocks, which tend to show superior growth rates in the long term. Wealth can be preserved and grown by ownership of equity in good businesses. Although stocks can decline dramatically in bear markets, historically they have recovered. The collapse of the tech bubble in 2000 lasted for 30 months from top to bottom on the S&P 500 composite index, while the credit bubble collapse in 2008 lasted only 17 months from top to bottom.
Keeping history \u2014 and the long term \u2014 firmly in mind can help clients stick to their retirement plans.\t IE<\/b><\/p>\n","protected":false},"excerpt":{"rendered":"
Long-lived clients and anemic fixed-income returns mean that financial advisors should be looking for ways to keep investments growing strongly well into the retirement years<\/p>\n","protected":false},"author":4,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":[],"categories":[3013,3018],"tags":[2346],"yst_prominent_words":[],"acf":[],"_links":{"self":[{"href":"https:\/\/www.investmentexecutive.com\/wp-json\/wp\/v2\/posts\/317627"}],"collection":[{"href":"https:\/\/www.investmentexecutive.com\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.investmentexecutive.com\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.investmentexecutive.com\/wp-json\/wp\/v2\/users\/4"}],"replies":[{"embeddable":true,"href":"https:\/\/www.investmentexecutive.com\/wp-json\/wp\/v2\/comments?post=317627"}],"version-history":[{"count":1,"href":"https:\/\/www.investmentexecutive.com\/wp-json\/wp\/v2\/posts\/317627\/revisions"}],"predecessor-version":[{"id":363322,"href":"https:\/\/www.investmentexecutive.com\/wp-json\/wp\/v2\/posts\/317627\/revisions\/363322"}],"wp:attachment":[{"href":"https:\/\/www.investmentexecutive.com\/wp-json\/wp\/v2\/media?parent=317627"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.investmentexecutive.com\/wp-json\/wp\/v2\/categories?post=317627"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.investmentexecutive.com\/wp-json\/wp\/v2\/tags?post=317627"},{"taxonomy":"yst_prominent_words","embeddable":true,"href":"https:\/\/www.investmentexecutive.com\/wp-json\/wp\/v2\/yst_prominent_words?post=317627"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}