Financial Planning

Investing To Fund Your Retirement Cash Flow


Mark McNulty


June 20, 2016

June 20, 2016

The following is an excerpt from Module Six of Mark McNulty’s new book, The $6 Million Dentist: Successful Succession in 8 Modules

Each prior module in this guide dealt with important decisions you eventually must make on your way to a successful retirement, such as:

When you’re going to sell your practice How you’re going to sell your practice What you can spend in retirement Which accounts you’re going to draw on to fund your retirement cash flow.

This module is where it all comes together. You’re ready to implement “the plan” of how you’ll invest your nest egg money to generate the cash flow you’ll need to enjoy the rest of your life.In order for your nest egg to outpace inflation, you’ll need exposure to the stock market. Other types of investments such as bonds, GICs, and annuities are simply paying too little to keep pace with inflation. Since you’ll have no choice but to be exposed to the stock market, let’s begin this module by looking at some specific ways to mitigate the risks of this type of investment.

Sequence of Return RiskEven if your investments provide a good, long-term average return, the order in which those returns are received annually can have a negative effect. This is called sequence of return risk. To understand this concept, take a look at the chart below.

It would appear 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 per cent rather than the bond market, the Bond Index – XBB, with 6.16 per cent. However, now look at the second chart below. If you had invested $100,000 in both securities and started withdrawing 8 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. How is this possible? If your portfolio declines and you withdraw money, there are fewer dollars available to participate in the recovery.

The charts illustrate two important points that should be the foundation of your investment strategy:

1.Investing at this stage is not about getting the best return, it’s about getting the most consistent return.

2. The greatest risk you face isn’t that the stock market will decline, but that the stock market will decline and you’ll need to sell to fund your retirement.

The Four-Year Rolling ReserveAnother way to mitigate the negatives of being in the stock market is a solution we came up with at McNulty Group called the Four-Year Rolling Reserve. We looked at the rolling annual returns of various stock markets since 1950. By rolling annual returns we mean, for example, January 1, 1950 to January 1, 1951; January 2, 1950 to January 2, 1951, etc. If we continue this sequence of annual rolling returns until Dec 31, 1952 to Dec 31, 1953, we have just one of the many four-year periods of rolling annual returns from 1950 to the present day.

If we examine this period, we find there were many corrections and crashes but that, most significantly, only a small percentage of time did the various stock markets remain in a negative position for more than four years.

What does this mean? If you ensure that sufficient money for four years is set aside in low risk, liquid assets in the accounts where your retirement money is to come from (as discussed in a previous module), you can lessen the risk you’ll retire during a bear stock market. Granted, you’ll earn very little interest on the money set aside in money markets or short-term bonds for those four years. However, we consider this lost earning ability as an insurance premium, and we always have funds for the retirement paycheque.

In SummaryAll in all, when it comes to the strategies for managing your retirement income you must be prepared to work with your financial advisor to make the best decisions for your future. If the strategies you choose aren’t a good fit with your lifestyle, they simply won’t work out in the long term – and the long term is what you need to start focusing on now.PA