The Canadian Money Roadmap

Are your investments appropriate for your retirement timeline?

December 01, 2021 Evan Neufeld, CFP® Episode 33
The Canadian Money Roadmap
Are your investments appropriate for your retirement timeline?
Show Notes Transcript

EPISODE SUMMARY

On this episode, Evan provides a framework to think about whether your investments are appropriate for your retirement timeline.  Managing risk might mean you need to make adjustments to your portfolio as you get closer to retirement and throughout your retirement years. 

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TOPICS IN THIS EPISODE

  1. Investment risk and reward 
  2. Matching risk with your investment timeline 
  3. How to manage and assess risk 


OTHER EPISODES

26. Rebalance Your Investments 

27. Will you Have any Guaranteed Sources of Income in Retirement


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Hello and welcome back to the Canadian Money Roadmap Podcast. I'm your host, Evan Neufeld. Today we are continuing with my retirement readiness series and we're going to be focusing on whether your investments are appropriate for your retirement timeline.

All right. If you're joining us for the first time today, welcome here and if you want to follow along with this retirement readiness series, head over to my website www.evanneufeld.com and you can download my retirement readiness checklist right there and follow along with us. But my goal here is to give you a little bit more information so you know how to answer those questions so you can know if you are ready to retire or not. Now we're talking about your investments and your savings a little bit more today and discussing whether the investments that you have are appropriate for you based on when you plan to retire and when you need to start spending.

So, what does that actually mean, for something to be appropriate or not? Well, every investment will represent a certain amount of risk and thus has certain amount of potential reward along with it. Risks can be many things, but volatility, meaning the rapid change in values of going up really quickly or down really quickly. That's the main one that I'm going to be focusing on. If there's no risk, meaning there's no chance your investment will decrease in value, the upside potential of that investment will also be low. If there isn't a chance that your investment will decrease in value, meaning it's guaranteed and your investment is actually supposed to return a reasonable amount of money or a lot of money, then you're dealing with a different type of risk called fraud and you really want to be careful about that.  Obviously, you rarely know you're in a fraud until it's too late, but generally speaking, you want to avoid things that offer guaranteed returns that sound too good to be true. If it sounds too good to be true, it probably is. But anyways, risk and reward are typically always linked in such a way. So more risk implies more long-term reward.  Of course, because in the short term, that's where risk shows up. It's not always risk and reward. Sometimes it's risk or reward. 

But to talk about this a little bit more, think of a mountain climber. I'm from Saskatchewan, so I'm not a mountain climber by any means, but I could imagine that the best views come from some of the most remote, and potentially dangerous peaks. Thinking of Everest in particular, but many others around the world of course. So would you say that there are risks associated with mountain climbing? Uh, yeah, I definitely would. Would it be a rewarding experience for people that can handle that kind of risk? I would say also, yes. But is it for everyone? Absolutely not. Right. You need to be in certain physical condition to be able to do that. You have to have experience with mountain climbing? Climbing a mountain is not for everyone. And unfortunately, we've seen problems associated with that with people that think that they can just do it without the experience, without the gear and without the proper supports. 

Another more interesting analogy here would be if you've ever traveled to Hawaii or Maui in particular, there's this town on the, I believe it's on the north side of Maui called Hana. And if you're there, I remember seeing a number of people wearing shirts that say, “I survived the road to HANA”. It’s a winding, narrow road, maybe they're all paved, but maybe there's some dirt patches in some places, a little sketchy. But along the way, you'll see waterfalls, secluded beaches, and you can imagine in your mind's eye here, what a secluded part of Hawaii might look like. But if you get carsick, that's immediate no, Right? So is that risk of getting sick worth it? You know, people are describing it as surviving the road to Hana, for people that's immediate no, its just not going to happen. 

So when we talk about investing here, let's put some of these investments on a risk spectrum, meaning from lowest to highest. So we could talk about cash, GICs, bonds and than individual stocks. There are many other things that can put in there. Maybe cryptocurrency would be even further yet, but mutual funds and ETFs would be investments that include cash, GICs, bonds, individual stocks, maybe crypto, or any combination of these. So you can find mutual funds and ETFs across the risk spectrum, but the underlying investments would kind of go in that order. 

So I don't believe that at a certain age or arbitrary time period, like the day you decide to stop working, is the time when things suddenly become inappropriate. Meaning if you have mostly stocks in your portfolio, the day you retire, isn't the day that you only have cash. Going all in or all out isn't what I'm getting at here. But as you get older, the average percentage of your portfolio should adjust to reflect what you need the portfolio to do at that time.

When you're in your accumulating years, meaning you're saving, you're still working, you want it to grow. That's the whole point. You want your portfolio to grow. You don't need income from it necessarily because you're still working. You have employment income, but you need your money to be working too. So having a larger portion of riskier assets like stocks would make sense. I'm a believer in diversification and buying mutual funds or ETFs or a wide variety of individual stocks would cover this. But as you get closer to retirement, you might run into what we call sequence of returns risk. This means that even if your average rate of return is reasonable and in line with what you expect, the time that you get that return makes a difference on the overall health of your portfolio. For example, if you're retiring in two years and your investments decreased by 50%, you'd be a big trouble because two years from now, you need to start spending that money. But for someone early on in their career, a 50% decline could almost be viewed as an opportunity more than a risk because they have the cashflow to buy more in time to be able to leave that portfolio alone.

So the sequence that your good years and bad years happen are both out of your control, but highly impactful on your portfolio. So you need to approach retirement with caution. As I've said before, I don't recommend being all risk and then no risk at any point in time at retirement in particular, because in retirement you generally need your portfolio to provide your monthly income, but also some growth to make sure you keep up with inflation and because most people simply can't afford to not have any investment growth through retirement.

So a retirement portfolio generally can't completely be risk off.  An  approach that I recommend to clients is to have a what I call a “war chest” or a pool of low or no risk investments, which could include cash available to be your source of income. I recommend two to three years worth of income in this war chest, so if you're planning to withdraw, say $50,000 a year, have a 100,000 to 150,000 in these low-risk investments. That way, the remaining part of your portfolio in riskier investments, which have more upside to make you more money. These riskier investments don't need to be touched in the case of a market decline and it would give them time to rebound.

Now here's the problem. If you have some risky, some not risky, but you're only spending the not risky funds, meaning you're spending out of your war chest every month. The investments that remain are more risky on average. So just for simple examples, that we can be on the same page here, say you have two stocks and a bond and you spend the bond. So now it's gone and now you're only left with two stocks left in your portfolio. So now your portfolio is as risky as it gets, it's only stocks. So this is the case for rebalancing and I have an episode about this if you want to go back and look, but generally I recommend having a plan for rebalancing. So sometimes your advisor or broker can set up an automatic rebalancing program. Sometimes they'll do it manually, but overall, the goal is to keep your overall allocation mostly the same. You might be investing in a product that automatically rebalances behind the scenes, like a target date fund or something like that. But either way, make sure you have a plan to keep your portfolio in a correct allocation, because as you age and when you start withdrawing from your portfolio, things are just going to change. Manually rebalancing can be good too, of course, but you just need to be aware of transaction cost if they're applicable to you. I'm a big fan of automation, of course, but the doing things manually, you have the chance you might forget to do it. And you might have a greater chance of acting based on your feelings as opposed to a rule and so you might set up a rule that you'll look every quarter. And if your mix is say out by 10 to 15%, either way, then you'll do a rebalance. But if it isn't, then you'll just leave it alone. It's a lot tougher to do that when you're choosing to do it yourself, then when a computer is doing it.

So to answer the question of whether your investments are appropriate for you based on your timeline. Unfortunately, I can't really give you a specific rule of thumb or advice on that, but generally speaking, once you get closer to needing to withdraw from your portfolio, you would want to consider having some of that portfolio be in less risky assets. So if you're entering retirement with a portfolio of a hundred percent stocks. You really need to be aware of the risks associated with that allocation. The same thing is true on the other side, to be honest, if your portfolio is too conservative, you need to be aware of the risks of inflation and how interest rates will affect fixed income investments. Now that's maybe another topic for another day but being both too risky and too conservative can really work against you as you get closer. So that's why I like to recommend having that combination of both and having that war chest of low risk or no risk investments that you can draw your income from.

So is your portfolio appropriate for your timeline? Generally speaking only you know that, or if you work with an advisor who knows your situation and understands your situation personally, the two of you can come up with a plan to determine whether it is appropriate for you or not. And then along with that, as you need to start spending it in retirement, figure out your plan for rebalancing from time to time to make sure that you're not exposed to any specific risks throughout your retirement.

Thanks for listening to this episode of the Canadian Money Roadmap podcast. Any rates of return or investments discussed are historical or hypothetical and are intended to be used for educational purposes only. You should always consult with your financial, legal and tax advisors before making changes to your financial plan. Evan Neufeld is a Certified Financial Planner and registered investment fund advisor. Mutual funds and ETFs are provided by Sterling Mutuals Inc. 

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