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This article was published 7/7/2018 (816 days ago), so information in it may no longer be current.
Cat food tastes worse than it smells (trust this cat owner). Yet, many retirees may be fearing the prospect of such a menu option in their future. According to a recent report called Seniors and Money, commissioned by the Financial Planning Standards Council and Credit Canada, a quarter of Canadian seniors fear running out of money before they die. Perhaps it’s because the same number of those surveyed worried they may not be able to afford long-term care.
Or maybe it's because half of the respondents indicated they still had at least one form of debt, with almost one in ten (eight per cent) stating they will never pay it off. It could also be that retirement is more complicated, at least financially, than it?s ever been, says Scott Evans, a financial adviser at BlueShore Financial, a Vancouver credit union.
"Retirees are juggling a number of different things these days," he says.
Moreover, saving for retirement is a much different game of coins than saving during retirement.
"It’s about the decumulation of assets versus accumulation."
When building a retirement income from pensions, savings and other sources, taxes become a big consideration. Pay less tax; keep more savings for your needs. And while a high income in retirement is good, you don’t want too much or you start to lose government benefits like Old Age Security (OAS). Yet, creating a conservative investment strategy — often the plan of choice for many retirees — has also become very challenging in today’s low-interest-rate environment. In other words, the all-GIC approach doesn’t work well when the return on a five-year GIC is about two per cent.
"You’re not going to keep up with inflation," Evans says.
That’s a big change from past decades when rates were much higher on all conservative investments, says Michael Aziz, with Canada Protection Plan, which provides no-medical life insurance — increasingly popular with seniors seeking to leave something behind for their estate.
"In the ’80s and ’90s, GICs and bonds… returned eight per cent," he says.
Even bonds — a more complex version of GICs — are much trickier these days because they only provide anemic returns.
We’re also in an environment where the Bank of Canada and the Federal Reserve in the U.S. are hiking interest rates. And that is bad news for existing bonds in your portfolio. Rising interest rates and their negative impact on the value of your bonds are among the biggest risk many conservative investors — like retirees — face, says Phil Mesman, head of fixed income at Picton Mahoney, a boutique mutual fund firm.
"People think when we have higher interest rates that we will earn more income, and that’s true, but the challenge is the value of the existing bond portfolio goes down in the process."
Take a bond that pays an interest rate coupon of three per cent. If interest rates rise to four per cent, the value — or price — of that bond you own paying three per cent goes down. So if you have $1,000 of bond and try to sell it so you can then go buy a bond that pays a higher interest rate coupon, you might only receive $950 back in return.
Of course, you can hold onto the three per cent coupon bond until it matures — when it completes its five-year term, for example — and then you get your entire $1,000 back. But Mesman says many investors find it difficult to see their statements showing they’ve lost money on bonds because it is likely something they’ve never experienced before. Interest rates have fallen for decades for the most part, and that increases bonds’ value, which shows up as a positive return on a statement.
So some individuals seeing a loss for the first time may be inclined to sell. But even more concerning is inflation.
"If we have rising interest rates, part of that is due to inflation," he says. "Therefore, your income requirement will be higher as well, so you face the risk that your future income falls short of inflation."
To deal with this problem, retirees need a more complex approach to what used to be a simple solution. Mesman says they should consider owning at least three different bond funds in which managers are using different strategies. The more diverse the portfolio is, the more you can spread out risk, he says.
Today’s diversification is about looking beyond than North American stocks, Canadian bonds and cash, says Mike White, also with Picton Mahoney.
"A portfolio strategy should include nine different asset classes," says the portfolio manager who runs Picton Mahoney’s Fortified Multi-Asset Fund.
These assets classes are developed and emerging stock markets, government, investment-grade and high-yield bonds, and commodities (precious metals, industrial metals, energy and grains). Again, this helps to spread out risk, which reduces the volatility that can often negatively affect income.
The idea being that when one asset or more are ailing, others are doing well enough to provide positive returns overall. For example, when inflation is forcing interest rates higher — hurting fixed-income holdings — an allocation to commodities can offset those losses.
White says this is a change in the investment mindset of most retirees who in the past two decades have leaned on balanced portfolios — like 60 per cent stocks and 40 per cent bonds, or vice versa. This style of portfolio has done well, providing eight per cent annualized returns.
"But we’re at a junction where future returns are likely to be lower than what people have experienced for much of the last 20 or 30 years in a balanced portfolio," he says.
A more nuanced strategy is likely required, and that may make some retirees uncomfortable. But the alternatives are running out of money, or taking on a much more simple approach — though likely unappetizing to the latest generation of retirees.
That strategy being sticking to GICs, accepting their lacklustre returns and spending as little money as possible, White says.
"That’s as good a place to start as any."