David Aston
March 27, 2020
If you're retired, you've probably found investing to be quite a bit different compared to your working years.
A lot of that is because you likely depend on withdrawing a sizable and regular flow of cash from your portfolio to support your day-to-day living costs unless you have a good employer pension.
So you should think carefully about how to protect both your cash flow and your portfolio in the face of the current stock market meltdown.
Here are three things you can do now to help. First, take your withdrawals from the part of your portfolio largely unaffected by the stock sell-off. Second, review your long-term asset allocation and third, rebalance gradually in a way that supports your cash flow.
By now, you're probably familiar with the expert advice that you "stay the course" with stocks and not sell at beaten-down prices. You've probably also heard about the need to rebalance your portfolio at some point to make the most of the stock market recovery when it eventually happens. While this classic advice applies to all age groups, retirees are likely to find it both trickier to do in practice and particularly impactful if they don't do it properly.
A problem arises if you let the need for cash flow to support your lifestyle force your hand, causing you to sell stocks at low prices. If stock prices stay low and you need to keep selling stocks for an extended period, then your portfolio may become so diminished that you don't benefit much when markets eventually recover. In turn, that would increase the chances of depleting your nest egg before your time is up. The experts call this phenomenon sequence of returns risk because of the way the math works: a large percentage portfolio loss in the early part of retirement coupled with withdrawals has a much greater impact than an equal percentage loss plus withdrawals late in retirement.
Now we discuss ways to protect your cash flow in more detail:
- Draw funds from parts of your portfolio insulated from the stock meltdown.
Now that stocks have been beaten down in price, it is important to draw funds to live on without resorting to selling stocks at these low prices. Alternative sources of funds include interest and dividends generated by your portfolio. It also potentially includes gradual drawdown of fixed-income assets that are relatively unscathed by the market decline and related recession fears. These drawdowns could come from investment savings accounts, maturing government-insured GICs, or perhaps by selling investment-grade bonds (although prices for corporate investment-grade bonds have also suffered to a fair degree).
By drawing funds from these sources and leaving stocks untouched, you give your equities a chance to recover undisturbed.
Of course, no one knows how long the bear market for stocks is going to last. It could be months or it could years. So you should be prepared to keep this strategy going for quite a while.
- Review your long-term asset allocation
If you followed standard expert advice, you probably set a long-term target asset allocation that is balanced between stocks and investment-grade bonds or GICs. No doubt your actual allocation has been knocked off-kilter by the market meltdown. Now is a good time to review where you stand.
For example, assume before all this happened you had a $600,000 portfolio, which was split 50/50 between stocks and fixed income (which is a little on the conservative side). If your stocks fell 30 per cent and fixed income was unchanged in value, then your portfolio would be worth $510,000 today, a 15 per cent drop over-all, and your asset allocation would now be 41 per cent stocks and 59 per cent bonds.
You probably understand the classic investment advice that you should "stay the course" on stocks during a market meltdown and not sell them. But, in that example, that still leaves you with only 41 per cent stocks, well short of your target asset allocation. What further actions should you take?
You may feel burned by stocks and tempted to change your target asset allocation in favour of more fixed income.
While that's not out of the question entirely, be careful about any emotional knee-jerk reaction. If you went through a proper process in the first place to figure out your target asset allocation based on your risk tolerance and other factors, then there is usually no reason to abandon it now. Both fixed income and stocks should continue to have a place in your portfolio, and you'll need a healthy chunk of equities to drive the long-term recovery of your portfolio when stocks eventually rebound at some unknown point in time. At the very least, don't change course before you've had a chance to soberly think it through, ideally with the benefit of professional investment advice.
Once you've validated (or adjusted) your long-term asset allocation, the next question is figuring out how to rebalance your portfolio to get back to target.
- Gradually rebalance in a way that supports cash flow needs.
The experts advise at some point you should rebalance by selling fixed income and buying stocks in order to get back to your target asset allocation (although there is no consensus about how or when).
While that's good advice, retirees should adapt it based on their circumstances. Don't sell fixed income to buy stocks if it might cause your source of reliable cash flow to run dry while stocks could still be depressed. Then you might be forced to reverse course and sell stocks at a price that's just as bad or worse.
Of course, you may be deriving part of the cash flow that you use to support your living costs by drawing down fixed assets, as we discussed earlier. That essentially is a form of rebalancing, albeit a very gradual one. It reduces the proportion of your assets held in fixed income slowly over time.
Whether you go a step further to explicitly move money from fixed income to buy stocks should depend on your situation. If you have plenty of reliable cash flow to support your living needs for an extended period of time as discussed earlier, then taking this step at some point makes sense. (In my view, try to make sure you have your living needs covered by fairly reliable sources without the need to sell equities for at least five years and ideally 10. With interest rates falling and the reliability of dividends threatened by possible recession, be conservative in your projections.)
The way you rebalance can also help support reliable cash flow. For example, say an existing GIC is maturing. Based on current rates, you could buy a new GIC with a yield of around 2 per cent for either one-year or five-years at a smaller financial institution (but not the big banks, which are stingier). If you use the money instead to buy a Canadian blue-chip bank, telecom or utility stock, in many cases now you should be able to get a fairly reliable dividend yield of well over 5 per cent. While stock dividends aren't as assured as interest paid on government-insured GICs, buying those kinds of stocks should help grow your cash flow in a fairly reliable manner while also helping to bring the proportion of stocks closer to their target.
Rebalancing is important for retirees, but you should tailor the approach you use in order to support the flow of cash from reliable sources.
David Aston is a freelance contributing columnist for the Star, is a personal finance and investment journalist. He has a master's in economics and is a chartered professional accountant. His new book, "The Sleep-Easy Retirement Guide," was published in January and is available at bookstores across the country.
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