Say what? Stocks in retirement are risky?
Recently I read an article in The Globe and Mail suggesting relying on stocks for retirement income is a risky strategy. Say what?
Prem Watsa, the CEO of insurance and investment giant Fairfax Financial Holdings Ltd., stated “What happens with these low interest rates is that you have people searching for yield and taking risks that they may not understand, that they may not know.” Partially true. And sure, the world could be hit by another massive financial asteroid/downturn but I’m not about to run into a cave with cans of soup or a bunch of matches. Everyone has a bias when it comes to investing and I think Watsa has some as well. My understanding is Watsa has a history of buying put options and derivatives to bet against market movements. He is the founder and CEO of a major insurance company. His bearish calls are probably not a surprise.
Back to the article I’d like to think this particular case study was taken out of context. The article further stated: “…a friend’s 90-year-old grandmother was relying heavily on dividend-paying common shares for retirement income.” If a 90-year-old can live off dividends in retirement that means this investor must have a decent amount of capital invested. While complicated this is a great problem to have. Heck, living to age 90 is a great thing.
I get the fact that the equity markets are/have been a mess in the short term, the price of oil is causing heartburn for people, and we’re probably not going to see real returns from bonds above 2% for another few decades. However, to say that owning stocks in retirement is risky seems like fear mongering to me.
This why I side with Globe and Mail personal finance columnist Rob Carrick – who makes a case for a “bucket” approach to fund retirement, something I’m going to employ in some shape or form in another decade or so. In fact, I recently wrote about that here.
I will likely employ something like the following:
- Treat any income from our pensions like it is: fixed-income. It is my hope that most of our fixed-income will pay for basic retirement expenses (all food, all shelter and all clothing).
- I intend to keep about one-year worth of living expenses in cash savings.
- After the one-year cash fund is established I believe the rest of the portfolio will be split this way:
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- 50% invested in dividend-paying stocks from Canada and the U.S. (about 30-40 stocks in total). We will use the dividend income generated from these investments for living expenses, and
- 50% invested in a couple of low-cost, diversified, equity ETFs (like VTI) that invest in thousands of stocks. We will spend the distributions from these investments and draw down the capital over time.
These are some preliminary thoughts about how to fund our financial future – and as you can see – avoiding stocks is not one of them. The financial plan we have is to save and invest in stocks for income and long-term growth. We strive to keep our investing costs in stocks as low as possible for as long as possible. After investments are made every month we just live our lives with the money that is leftover and do what we please, ignoring claims the financial world is coming to an end.
Are stocks a risky play in retirement? What do you think?
I’m 66 and have been retired 11 years. Like Mark, my investments are 100% equities with some cash in a HISA. No bonds, no GICs. I don’t plan to make any changes as time passes. My living expenses are covered by my company DB pension, CPP & OAS which I consider to be the fixed income portion of my investments. (Like a large bond). Risk and volatility are different things. Risk is the possibility of losing your money. Volatility is the fact that other people will buy and sell your security at prices that go up and down. They are not the same thing. If you are a buy and hold investor in large cap dividend paying companies then volatility is irrelevant. Case in point: 2008-2009. My dividend income stayed exactly the same while other people sold the stocks that I held at ridiculous prices. It didn’t affect me in any way.
pwm,
“Case in point: 2008-2009. My dividend income stayed exactly the same while other people sold the stocks that I held at ridiculous prices. It didn’t affect me in any way.”
Nicely done! My dividend income actually increased during the great recession even though my portfolio was down close to 30% at one point.
Good to hear from you pwm. Risk and volatility are different things indeed. Long-term, I don’t have too much fear I will lose my money. My portfolio should grow over time with 100% equities – especially so with my basket of 30+ dividend paying large cap stocks – there should be growing income every month unless there are dividend cuts.
I’m trying to stay the course as much as possible for as long as possible.
During this past six months we have been selling a number of our stock funds and stocks that we hold and diversifying directly into mid term corporate bonds, We have now managed to ladder a few hundred thousand into bonds that mature over the next ten years.
Not guaranteed I know, but we feel much happier having this fixed income base. We will probably move more towards bonds over time, there is not the excitement of a nice market upturn but it is steady income that will not need too much care and attention over time.
I think it’s important to do what you feel is best Richard. If you feel happier with more fixed income, and that meets your needs, then that is the right decision. Long-term, I believe a 100% equity position for us coupled with our pensions, is the right call. At least I am hoping so.
I think that we are still at around 70% in stocks but we did make this deliberate decision to diversify.
You are right, it is what we are comfortable with and we are certainly not going to stray too far from your investment principals.
Thanks Richard. 70% seems like a healthy dose of stocks and in this day and age, if you want growth, need growth, you absolutely need equities.
The plan you describe above is more or less the blueprint I have in mind for our retirement!
The reason I am ok to hold equity in retirement is the time horizon, the “guaranteed” income from the state pension, the flexibility I am willing to take in my budget. that means that for a long time, my horizon should be beyond 10 years for a long time.
Other than that, I als have 2 kids and hope to pass on wealth to them. This means that my horizon is actually beyond what I can imagine. I hope they become frugal and money conscious just like me, so the equity can go to grand children. In that view, equity sure has a space in the portfolio. Especially when it is dividend paying equity. You can then life of the fruits and keep the tree.
Amber Tree, from what I’ve read, you sound like you have a very disciplined approach to investing underway. I have full confidence those values will be passed along to your children in some shape or form. You are growing a tree that should yield fruit for decades to come.
Hi Mark
I would agree with your point one that pensions (and CPP/OAS) are equivalent to fixed income and, in fact are better, since they are indexed to inflation.
As for your point two about keeping one year’s worth of living expenses in cash, I would suggest you may want to increase that to closer to two years since there is no guarantee that a downturn in the markets will be over in just one year. Having the additional flexibility may be useful in the future so you do not have to sell your ETFs in a down market.
While I agree with the logic of using dividends from either individual stocks or low cost equity funds (diversified outside of Canada of course!) to cover the rest of your expenses and to provide capital to draw down over time, I would suggest you might want to think about the impact of the dividend gross up & its impact on the amount you will receive from OAS. Excessive amounts of dividends will reduce OAS payments depending on your overall amount of income. Tax considerations are extremely important, especially in retirement.
Ralph
Thanks for the detailed comment Ralph. I’m sure we will consider keeping more cash as we get closer to retirement. I’ve always said plans are one thing and reality is another 🙂
I would agree and I’m learning this more as I invest: there are guarantees in a downturn and nobody knows how long they will last.
As I get older, I’m more convinced that owning my basket of stocks is a good thing coupled with more equity broad market ETFs. I appreciate your considerations about the dividend gross up and impacts to OAS. I’m also convinced being close to OAS clawbacks is a good problem to have in retirement. 🙂
Good discussion. One thing I would mention is that a person should be cognizant of the survivor’s portion of a DB pension. If the pension holder dies the income will likely be less for the survivor. In our situation with two moderate DB pensions and some term life insurance I don’t have a lot of fear of market fluctuations. Actually, we tend to buy more when the market has bigger drops.
Thanks for raising Lloyd. I think our pension has a 66% survivor’s benefit. We hope to have two moderate pensions eventually. Right now, we have 15-years each vested, which we’re very fortunate to have.
I will agree with Cannew.
I am 65 now and pulling OAS and a small company pension. I have not started CPP(QPP in my case) as of yet so I could be considered as still in the accumulation phase for my RRSP’s. That should change soon. 100% in stocks with dividends being re-invested at my discretion. The only RRSP that I can really follow (because it is a LIRA) has averaged a 9% annual increase, dividends and cap appreciation, Back in January it was down to an average of 8% whereas last year it was just over 10% average annual increases. So while the value of the LIRA has decreased from last year it has still averaged a 9% annual inrease year to date over 13 years. Not too bad for 100% stocks.
I am slowly buildng a cash emergency fund but it sticks in my craw getting next to 0% for this liquid asset. It is just nice to have if you have to balance out some low spots when the market dips. Or those unforeseen expenses like roof repairs, dental work or a Corvette.
Some of the problems with dividends is that they are not guaranteed to 1) always increase 2) never decrease or 3) be chopped to zero.
And, Lord forbid, there are not too many Nortels in your holdings. I had some.
At any rate I figure I will stay 100% in stocks but build the cash oile a bit higher to ride out the dips so as not to have to sell lower.
Will 1929 come again? Who knows! It is possible. So is crossing the street and getting run over.
RICARDO
“100% in stocks with dividends being re-invested at my discretion.”
I hope to be where you are Ricardo, working towards that every month actually 🙂
Regarding the cash, I guess I’m very conservative. I certainly don’t have a one-year cash buffer now, far from it, but I think it’s a process we’ll start working towards in another 5 years or so; if early retirement could be in the cards. I hope so! I prefer a i3 vs. a Corvette for the record.
Kidding aside, I see the value in 100% stocks. I recall Michael James is as well and he has more financial discipline than most, so he can handle it and then some. Thanks for your detailed comments. I will do what I can to avoid any future Nortel effect.
As mentioned by others, it’s a question of need. Does one need to sell stocks to receive income, or is the current dividend income sufficient or more than current and expected needs? If one is invested in just equity stocks which do not provide sufficient income than certainly it’s extremely risky.
For most DG investors, the need to sell is not an issue and there is probably a sufficient margin of safety that even if one wants to sell a depressed market will not cause a major problem.
I would not consider getting out of our 100% equity position. Our only issue is taxes, especially because of RRIF withdrawals are taxed at the highest rate.
Need but also opportunity cost. I think there are HUGE risks and opportunity costs with keeping money under your mattress. Long term, inflation is a massive risk whereas the stock market as a whole, for the long-term investor actually has very little.
“For most DG investors, the need to sell is not an issue….” I would agree. This is probably why since the money keeps flowing to you, you will not exit for your 100% equity position and I don’t blame you since you have more than enough (from what I know) to cover all expenses including some essential buffer. Very well done cannew!!!
Whether or not stocks are risky in retirement depends entirely on if you will be forced to sell stocks. If you are invested exclusively in high quality dividend growth stocks with long histories of raising their dividends, then it is very likely you will see rising income over time.
If your income needs are not met by dividends and you are forced to sell periodically, the volatility of stocks makes them a poor choice to go ‘all in’. They would still be an integral part of a diversified portfolio, however.
Certainly selling at the wrong time is risky and has negative consequences. As a reader mentioned to me via email recently, diversification and balance are good keys to investing. They are good keys to life. Thanks for the comment.
Some portion of stocks in retirement makes sense I think. That portion should be a significant portion if you retire early. At 90, your exposure in equity should be limited, unless you don’t plan to ever sell the stocks (i.e. passing them down), and there are enough margin of safety in your dividend income. I think it really depends on the situation.
I’ve also read the inverse though Tawcan, that you should probably increase your equities as you get older – as long as you have fixed-income to cover expenses. Many studies have been done over the years to identify the optimal asset allocation for folks but there really isn’t any other than “general rules”. I think in the end, when you retire, how long your retirement will last, when and how much of your portfolio you will need, the fees on your investments, taxation and many other factors like a legacy will dictate the need for stocks. In general though, I would say more investors want growth at any age and that means stocks. That’s probably my biased thinking.
My plan is to stay 100% stock until we have 1M$ invested, then begin to buy short bonds (VSB) up to 10% of the total. At this point, we should be 50 years old and able to work for another 10 years if needed. We always keep 3 months of living expenses in cash (10-15k$) but we could increase this up to 12 months later.
I dont know if it’s riskyier to be 85% stock at 90 years old or have nothing invested (like a lot of elders)?
“100% stock until we have 1M$ invested” – that sounds familiar to a plan I know 🙂
https://www.myownadvisor.ca/dividends/
I figure the $1M should churn out at least $30k in dividend income eventually. I’m being conservative but I like dealing with money this way.
“We always keep 3 months of living expenses in cash (10-15k$).” That’s excellent and smart I think.
As for your question: I don’t know if it’s riskier to be 85% stock at 90 years old or have nothing invested (like a lot of elders). I think longevity risk is real for the Boomer generation personally, so that means old and no money and very few options. That would be sad.
“If a 90-year-old can live off dividends in retirement that means this investor must have a decent amount of capital invested.”
Not necessarily as the 90 year old likely has other streams of income such as CPP & OAS. For those going this route I sugest reliable blue chip stocks like Canadian banks or utilities like CU or FTS which have never cut their dividends rather than ETFs which come with bumpy irregular distributions.
Fair, I might have jumped to conclusions but I certainly feel if most 90-year-olds can live off dividends, they the capital they have is either grand or they live rather cheaply.
I like your call with CU and FTS. I’d throw in EMA as well.
Yes Prem is a contrarian and bets big.
I think reading the whole article is necessary to get the full context. http://www.bnn.ca/News/2016/3/14/Watsa-warns-investors-face-huge-potential-for-pain.aspx
I took his view slightly differently than what you’re suggesting. I didn’t read it as don’t invest at all in stocks for retirement income but he was certainly very negative on the markets right now. He was suggesting there is potential for a 1929 style crash and that dividends aren’t necessarily safe especially when investors stretch for yield. In particular with the grandmother (older investor) thing he was saying that at age 90 someone had invested 85% of assets in equities and felt that was excessively risky. I would agree with that part. He then stated people should consider drawing down some equity instead or live on less income vs. the old rule of not touching capital, since a big crash would not give enough time for stocks to recover, in the case of older investors.
Your plan and ours will have a good base of fixed income (pension) in retirement. With Prems statements it “sounded” like the grandmother doesn’t even though she was at an advanced age, although we don’t know this for certain.
“For older investors, there might not be time to recover from the damage.”
I would agree with that. But all assets have risks in retirement. There is certainly some risk in holding bonds long-term and I also believe, maybe my bias, there is a huge opportunity risk by holding too much cash. Inflation over time is a massive risk to retirees. Then there’s longevity risk.
The Dow has and will always have its crises. If he just wants to “to make sure people realize there are risks”, I can buy that but to say things “don’t work today” is faulty thinking. Total returns have largely stayed the same for decades. I could be wrong but I don’t see things that different this time. I could be very young and naive though!!!
Thanks for your contributions as always.
I think the thrust of his argument is that this time is different- like 1929. A longer term massive crash potential with governments crushed with debt and employing extremely low interest rates trying to stimulate economies – largely without success. There are few or no more bullets in the gun…. Is he right – I don’t know. “Things not working today” probably refers to people being lured into higher risk assets than what they traditionally would be. Like the 90 year with 85% equities as advocated by their advisor and seemingly little fixed income. He of course has a vested interest in equities not working out right now, but I don’t see he is advocating retirees not being invested in equities or to hold a lot of cash.
Ha, you’re young but you’re not naive.
“Things not working today” probably refers to people being lured into higher risk assets….that’s quite possible.
Maybe upon more self-reflection, do I own 100% stocks because I like to gamble OR I’ve learned enough about investing to know that at my age, my total return is likely going to be better this way over the next 10-20 years, knowing I also have a pension as a “bond’?
I don’t know Prem’s context or motives when he made those remarks. There is usually some motivation behind what those big shots are saying 🙂
It’s clear you have spent considerable time on your plan (understatement) and fully understand and accept the risks. It’s certainly not because you’re a gambler. You are fully versed and comfortable with this tact, and will have benefit of significant pension (bond) income. That’s another thing Prem seems to suggest that may not be true with the 90 year old- they may not understand the risks/strategy they have under their advisor.
Yes, I agree over time a 100% equity portfolio has a much better likelihood of outperforming a more balanced approach.
I also agree he has a big motivation with his bet. We don’t know if he will be right, but coincidentally Fairfax Financial is my largest bond holding and also my largest CDN stock holding and both have been very kind to me. LOL, I hope he knows what he’s doing in some regard.
LOL about your top holdings. Very well played and very kind indeed.
http://web.tmxmoney.com/quote.php?qm_symbol=FFH
I appreciate your comments RBull.
It’s all relative when it comes to discussing risk. If you have enough cash that you can put it in a saving account earning a couple of percent and fund your whole retirement like that, it’s clearly safer. But how many people is that really realistic for if they retire at 65 and happen to live until their 90’s?
For the majority there needs to be some growth over that period and you need to go into a “riskier” investment to achieve that.
Good point Chris. What you think will happen at age 65 or 90 for that matter, may never happen. Theory and reality are different. I will simply be VERY happy to have any health at age 90. If so, I can blog about it.
Stocks are riskier than other fixed investments such as bonds and GICs so probably couch potato strategy (say 40% equity and 60% fixed income) would work better for people who are in retirement age. That being said, I am in my early 30s and my portfolio is 100% equity which will perform significantly better than fixed income over a long time horizon.
Thanks for sharing!
I’m a bit biased based on my own approach but I think anyone is their 30s who intends to invest for at least another few decades shouldn’t bother with bonds.
I think that strategy makes a great deal of sense. The old school notion that fixed income should be 100 minus your age is clearly outdated. The notion of treating CPP/OAS as fixed income is logical, and of course anyone with a healthy DB pension plan should view that the same way. For those fortunately people, the rest of their portfolios could be comfortably held in equities.
This also makes sense when you consider most recommend portfolio drawdowns of 3%-4% per year. If you are able to generate a 2%-3% yeild, then much of your capital won’t have to be touched at all. Yes, that erodes from assumed capital growth inherent in those models, but the idea of living off one’s dividend stream rather than touching capital is no doubt reassuring to most.
Thanks BartBandy. Those old school rules don’t make much sense, although I do agree with the 4% rule to a large degree. It helps with the slow depletion of capital.
I see CPP and OAS as fixed income and rightly or wrongly, I see my pension plan at work as a “big bond”. This means for my wife and I, we’re 100% stocks and likely always will be.
We hope to generate 4% yield from our capital and live off that in another 10 years. The capital appreciation (of investments) will/should? take care of inflation. This means we can drawdown our portfolio for the most part, on our own terms. I believe this is a sound approach for us based on our situation.