What should retirees do to protect their income?
Most retirement planning is focused on the period before retirement and how to accumulate wealth so that you have enough to retire. When you do get to retirement, your financial focus will likely change from accumulation to income. Financially, this is a big shift in thinking. It is important to look at ways to invest to protect the portfolio from too much risk.
Sam, for example, is 69 years of age and fully retired. Like many retirees, his small company pension and government benefits will not be enough to live on. Sam needs to supplement income with his portfolio of investments both inside and outside the RRSP. Let’s look at a few key ways Sam can protect his income from volatility.
Hold more fixed income
Diversification is a message that has been around for a long time. It’s the old theory of not keeping all of your eggs in one basket. The key is to diversify properly.
Sam has a portfolio where there are 17 different investments including both stocks and mutual funds. Although the portfolio is diversified by number of investments, most of the investments do the same thing. In the portfolio, 95% of the holdings were invested in Canadian Stocks. Five of the holdings were Income Trusts which accounted for 65% of the total portfolio. When the government announced some surprise changes to the taxation of income trusts, his portfolio took a big hit.
Sam’s portfolio was not well diversified and one could easily argue that Sam had too much exposure to stocks at the age of 69. There is a long time rule of thumb that says your age should represent the percentage of guaranteed conservative assets in the portfolio. For Sam, the rule of thumb would suggest that he should have about 70% of his total portfolio in fixed income investments and only 30% in the stock market. While this may only be a rule of thumb, the point is that Sam is probably a little light on more secure fixed income investments.
Daryl Diamond, retirement income specialist with Diamond Retirement Planning in Winnipeg believes that retirees drawing income should hold enough conservative assets to generate at least 3 years of income, if not a little more. Diamond feels that being too risky in a portfolio can be incredibly damaging to the longevity of a portfolio. Keeping a certain allocation of money in guaranteed investments ensures that income will always be secure and consistent even if the markets take a hit. Keeping some money earmarked for safety allows the rest of the portfolio that is exposed to the market time to recover when markets experience volatility.
DIVERSIFY your income
Whether markets go up or down, Sam’s pensions and government benefits are not affected. In other words, they are good diversified streams of income.
In the pension world, fewer retirees will collect pensions because of current employment trends. Those that are lucky enough to have defined benefit pension plans are considering the option to move pension assets out when they sever employment only to put the money into non-guaranteed assets exposed to the stock market which is unpredictable and risky. Remember that pensions are the best way to ensure guaranteed lifetime income because they take the guesswork out investing. If you don’t have a pension, you can create guaranteed lifetime income by purchasing a life annuity.
In the last 8 years stock markets have been volatile and unpredictable. Retirees with pensions or annuities, not only have diversified their incomes to protect themselves but they generally are less affected by what happens in the stock market. Retirees like Sam, should look at pensions and life annuities as great ways to create stable guaranteed lifetime income.