If you invest in market-based securities such as stocks and bonds, you are bound to experience the odd year of poor investment performance. This should be tolerable, even in retirement. What you want to avoid is having too many of the bad years early on in retirement.
Consider two retirees, Ed and Laurence. Both retired at the beginning of 2001 with $100,000 in their registered retirement savings plans. Ed chose to invest only in U.S. stocks, which mirrored the performance of the S&P 500, less fees. Laurence stayed in Canadian stocks (mirroring the S&P/TSX). Both paid investment fees of 1 per cent.
If neither of them ever made a withdrawal from their accounts, Chart 1 shows that Ed would be ahead of Laurence in January, 2022, by about 10 per cent.
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Now let’s assume that Ed and Laurence drew a steady income from their portfolios over this 21-year period. Their withdrawals were based on the 4-per-cent rule which means they withdrew 4 per cent – or $4,000 – in the first year and then increased that amount by inflation in future years.
As Chart 2 shows, Ed is no longer doing so well. The balance in Ed’s account drops to just $6,500 by January, 2022. By contrast, Laurence still has $119,100 left at that point, which is more than when he started. How could this have happened?
Ed’s problems can be traced back to the first eight years – 2001 to 2008 – when his portfolio did terribly. The first decade of the 21st century is often referred to as the “lost decade” by U.S. investors. Even though Ed had much better investment returns than Laurence after 2009, the damage had been done.
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The takeaway is that you absolutely need to avoid terrible investment performance in the first few years of retirement. This may involve pursuing some or all of the following actions:
- Reduce investment fees.
- Diversify geographically.
- Consider investing in five-year guaranteed investment certificates while rates remain high.
- Buy high-dividend Canadian stocks in safe companies (there are exchange-traded funds for these).
- Put part of your portfolio in long-term government bonds (also ETFs for this).
Note the last three of these strategies are viable only because of the current high yields on certain stocks and bonds. Also, you might want to avoid the 4-per-cent rule for making withdrawals – as Ed shows, it’s not always safe.
Frederick Vettese is former chief actuary of Morneau Shepell and author of the PERC retirement calculator (perc-pro.ca)
