Back in April 2008, I wrote an article for The Professional Advisory entitled “How does investing change in retirement”. I thought now might be a good time to revisit the numbers.
Of all the dentists I have met in the past twenty years, all but nine will be living off a portion of the capital in their portfolio. In other words, their nest egg will not produce enough income to finance their retirement lifestyle on its own. They will also be “eating into” their savings. This isn’t necessarily a bad thing. You worked hard for the money and should enjoy it in retirement. The problem is that in order for your nest egg to outpace inflation, you need exposure to the stock market. Bonds, GICs and annuities are simply paying too little to keep pace with inflation. Since you will have exposure to the stock market, there will be times your portfolio is down. This leads you to exposure of Sequence of Return Risk.
What is this?Sequence of return risk is the danger that while your investments may provide a good long-term average return, the order in which those returns are received annually has a negative effect.
Take the chart below as an example. It would appear that you would have been better off investing in the stock market, the S&P/TSX Index – XIU with its average annual return of 8.06 percent rather than the bond market, the Bond Index – XBB with 6.16 percent.
However, look at the chart below. If you invested $100,000 in both securities and started withdrawing eight percent of the portfolio annually, you actually would have been better off in the bond market, XBB.
After 10 years, the value of the portfolio invested in bonds is higher by $21,427.
Why is that?If your portfolio declines and then you withdraw money, there are fewer dollars available to participate in the recovery.
What should you do?I encourage you to test your sequence of return risk. In my opinion, minimizing this risk is of paramount importance for outliving your money. Ask your advisor to run a Sequence of Return Risk Test on your portfolio. Then ask them to show you illustrations of strategies which will reduce that risk.