When an investor transitions into retirement, the sequence of their investment returns becomes a material consideration. During the accumulation stage (pre-retirement), the sequence of returns does not make a difference to their long-term results since the disciplined investor can patiently wait out the inevitable market declines:
However, it’s an entirely different game in retirement, since investor’s begin to draw from their portfolio. Let’s assume that the below 3 scenarios draw $25,000 annually from a $500,000 investment portfolio, with the below return profiles:
Source: RBC GAM
- Mrs. Scenario A earns 6% per year on her retirement portfolio and draws 5% ($25,000 per year). After 10 years of reinvesting a slightly larger capital amount at 6%, her retirement portfolio has grown to $565,904.
- Unfortunately, when Mr. Scenario B retires, there is a market drawdown. In year 1, he draws 5% from his investment portfolio while crystallizing a 9.3% loss. This results in less capital for reinvestment, and after 10 years his portfolio is valued at $489,935.
- Alternatively, the markets are strong when Mrs. Scenario C begins retirement. This leads to more capital for reinvestment at the beginning of retirement, and after 10 years her portfolio value is $572,677.
This clearly demonstrates that retirees must be thoughtful of the sequence of their investment returns in retirement; despite all 3 scenarios averaging the same 6.0% return over the 10-year period, the sequence of returns made a difference on their end portfolio value. When portfolio losses were realized in year 1, it had a detrimental long-term impact on their end portfolio value. Therefore, it is necessary to have a strategy in place that effectively provides income when markets, and the value of your accounts, are down.
Once the appropriate asset mix is determined in accordance with your plan and risk tolerance, we suggest employing a cash wedge in your retirement portfolio. A cash wedge involves earmarking the anticipated portfolio withdrawals for the next 5 years with investments in secure interest-bearing investments (i.e. Cash equivalents, GIC’s, and Investment Grade Fixed Income). In this way, you provide yourself the luxury of time if the markets dip early in your retirement, as you have a 5-year buffer for your equity investments to recover (as they throw off dividends, which may replenish the cash wedge).
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Quick Hits
- A neat infographic from the Wall Street Journal, “How Retirees Spend their days”:
- Legendary investor Bill Miller once opined that, broadly speaking, there are 3 sources of advantage an investor can have: informational (knowing more than others), analytical (interpreting information differently), or psychological (“behaving” better). Of these 3 advantages, I think investors should prioritize cultivating strong behaviour towards their investments. Numerous empirical studies have shown that the average investor achieves subpar long-term results because their emotions often drive them to make poor investment decisions – in other words, they tend buy at the market top and sell at the market bottom. Appreciating how powerful emotional, psychological, and behvioural biases are, investors can sharpen their “behavioural sword” by taking a long-term approach and viewing stocks as an ownership share of a real, operating business. Curiously, this perspective – championed by none other than Warren Buffett – is not very common: as you’ll notice in the below infographic, the average holding period of shares on the New York Stock Exchange continues to shorten. Clearly, most “investors” in the market are not viewing stocks as businesses, but rather as chips at the roulette table. By remaining a goal-focused, disciplined, long-term investor, you put yourself in the best position to achieve your financial goals.
Source: Visual Capitalist
- One of the businesses we own for many clients is Constellation Brands, a provider of alcoholic beverages (Ticker STZ). One of their brands, Modelo, recently became the top selling beer in the US:
Source: Wall Street Journal
- “A longer-term perspective of bond yields shows that the late 60’s through to the late 90’s was a very unusual period for interest rates. Aside from then, yields have generally held within a range defined by 2-3% at the low and 5% at the peak. The drops below 2% were also extraordinary, even placed within the context of 150 years of U.S. interest rate history! The latest surge in yields has suddenly restored them to levels more consistent with history.”
- “Stocks leveraged to earnings growth prospects associated with the artificial intelligence theme have done an overwhelming proportion of the heavy lifting, representing roughly 83% of the year-to-date gains, as the chart illustrates. A study by RBC Capital Markets found that performance following similarly imbalanced periods since 1990 did not have a consistent pattern— sometimes the market rallied and at other times it sold off. Here again, for this cycle, we think performance will hinge on whether a recession unfolds, causing earnings to retreat.”
- Great points- worth repeating again and again- underscoring the benefits to populating portfolios with quality, dividend growing companies. From our Portfolio Advisory Group:
Please feel free to reach out if you have any questions. Have a great month!
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