Hello everyone, and welcome to the Retiring Canada Podcast. In today’s episode, we're going to discuss how to avoid common pitfalls that can jeopardize your retirement. Specifically, we will cover:
1. Two retirement risks you probably don’t think about.
2. Ten ways to mitigate these risks.
3. A few action items for you to consider.
Now, the title of this episode is quite obviously tongue-in-cheek. No one wants to destroy their retirement plans, and my goal is to ensure that you don’t. The simple fact is that you only get one shot at retirement, and I think most of you would agree that you really do not want to un-retire and go back to work.
So today, I want to discuss two headwinds that have the potential to derail your retirement and force you back into the workforce if not thoughtfully planned for.
But before that, if you have been enjoying the podcast, please consider leaving us a 5-star review in your favorite podcast app. This helps our message reach more Canadian retirees who definitely do not want to destroy their retirement and would prefer to stay happily retired.
Now, admittedly, there are more than two risks that can derail a retirement. Poor health, inflation, and emotional investment decisions driven by fear or greed can also call into question the long-term sustainability of one's retirement. Today, however, I will get a bit more technical and speak about two key headwinds that could push you off course as you near and enter retirement: Sequence of Returns and Reverse Dollar-Cost Averaging.
Both of these, if not accounted for, will increase the probability of your retirement plan failing.
Let’s start with Sequence of Returns. In simple terms, Sequence of Returns refers to the variability of investment returns you experience in your retirement portfolio. If over a 10-year span, your portfolio returns an average of 6%, the path over those 10 years wasn’t a straight line of 6% each year. Instead, there were up years with double-digit returns and down years with negative losses.
So, although the end result after 10 years may be an average 6% rate of return, the path to getting there had its ups and downs. This is your Sequence of Returns.
Why does this matter?
Well, if you are an accumulator and you aren’t touching your nest egg, it makes no difference to you how you ended up with a 6% return after 10 years, as long as you stayed invested. However, for the retirement investor, you don’t have that luxury, as you are actively drawing on your investments to live.
This is why retirement income planning is so incredibly important, as you are exposed to the greatest amount of risk in those first few years of retirement. Think about it. If your retirement investment goes down by 10% in the first year and you withdraw 5% to live off, your portfolio is down 15% total right out of the gate. Follow that up with another bad year of -5%, plus your 5% withdrawal, and in just two years, your portfolio has decreased by 25%.
To bring your account back up to its original amount in year three and continue to draw 5% from your portfolio, you would need to earn nearly 40% to get back on track. Crazy stuff, right? Just one or two bad years at the beginning of retirement can completely put your retirement at risk.
We don’t know what will happen in the markets or what Sequence of Returns you will receive, so it is crucial we make a plan that factors in Sequence of Returns risk. It could be the difference between a happy, stress-free retirement versus having to unretire altogether.
The second headwind is closely related to Sequence of Returns. However, with this factor, you do have some control over its outcome. This is called Reverse Dollar-Cost Averaging. In simple terms, it’s periodically pulling money out of your retirement accounts to put into your bank account.
You have probably heard of Dollar-Cost Averaging – an investment concept for investors who add money to their retirement accounts monthly, “averaging” their investment purchases into the market rather than trying to time their contributions. With Dollar-Cost Averaging, you are purchasing investments regardless of the price at the time. The opposite is true for Reverse Dollar-Cost Averaging, where you are selling investments regardless of the price or market conditions.
This is where developing a proper investment allocation that includes low-risk investments, a cash reserve to defer selling investments during down markets, and having a solid budget that keeps you living within your means becomes imperative.
Sequence of Returns risk and Reverse Dollar-Cost Averaging are intertwined and add significant complexity and risk to your ability to retire and stay retired.
By now, you might be thinking, "Okay, Michael, how do I address these risks?"
Let me share with you ten key strategies to help address these risks and mitigate their impact.
1. Diversification
This one you’ve probably heard before: don’t put all your eggs in one basket. Diversification can be thought of in broad terms, like how much equity and fixed income you have in your portfolio, and in more refined terms, like the geographical allocation, industry sectors, and bond durations. The most common issue we encounter is a concentration of holdings in the Canadian market, which only makes up a little over 3% of the global stock market.
2. Live Within Your Means
Retirement is a significant lifestyle pivot, including a shift in how you think about money and investments. The early years of retirement are crucial, especially if markets are turbulent. It’s essential to have a budget and stick to it, even delaying big purchases if needed.
3. Make a Retirement Income Plan
Develop a plan that moves money from your investments to your bank account tax-efficiently. Determine your fixed income sources, such as the Canadian Pension Plan, Old Age Security, employer pensions, and fixed annuities. Plan for market downturns by holding high-interest savings, GICs, and target-date bond funds.
4. Consider Annuities
Depending on your income needs, risk tolerance, overall assets, and health, consider adding a fixed annuity to your retirement plan. Annuities provide a steady income stream and can reduce market volatility risk.
5. Bond or GIC Laddering
Having a portion of your holdings in low volatility or guaranteed solutions like GICs can help defer selling equities during market downturns. Laddering refers to staggering the maturities of these investments.
6. Have an Action Plan for Market Drops
Execute your plan when needed. Decide in advance when to draw from high-interest savings or other low-risk investments and understand the tax implications.
7. Stay Invested
Assuming you have proper asset allocation and a cash reserve, stay invested with the balance of your long-term portfolio. Market timing is risky and often unsuccessful.
8. Asset Location
Ensure your investments are located efficiently across your accounts to minimize taxes and maximize your after-tax income.
9. Consider Alternative Assets
Alternatives can provide smoothed return profiles and low correlation to traditional equities and fixed income, adding resilience to your retirement portfolio.
10. Discover Our Fundamental Retirement Plan
We specialize in helping retirees, and our Fundamental Retirement Plan is designed to mitigate Sequence of Returns risk and Reverse Dollar-Cost Averaging. Visit fundamentalwealth.ca to learn more.
Alright folks, that will do it for today's episode. Your action item is to review these ten strategies and assess which ones you have in place. Here they are again:
1. Diversification
2. Living within your means
3. Creating a retirement income plan
4. Considering annuities
5. Learning about GIC or bond ladders
6. Having a plan for when the market drops
7. Staying invested
8. Asset location
9. Considering alternative investments
10. Discovering our Fundamental Retirement Plan
Be sure to sign up for my weekly Retiring Canada newsletter. And remember, when it comes to your retirement, don’t take chances.
Make a plan so you can retire with confidence.
All comments are of a general nature and should not be relied upon as individual advice. The views and opinions expressed in this commentary may not necessarily reflect those of Harbourfront Wealth Management. While every attempt is made to ensure accuracy, facts and figures are not guaranteed, the content is not intended to be a substitute for professional investing or tax advice. Please seek advice from your accountant regarding anything raised in the content of the podcast regarding your Individual tax situation. Always seek the advice of your financial advisor or other qualified financial service provider with any questions you may have regarding your investment planning.