Retirement, or as we call it at my house the Promised Land, is a time that we all know is coming. Retirement demands that our investments provide the income needed to replace most of the stream of funds we used to receive from employment. In addition, our retreat from the world of work requires that we shift our assets to a more conservative posture – not all at once, but over time.
In order to prepare for your entrance into the Promised Land you need to set a theoretical date when you would be willing to make changes to your lifestyle. Once you have established a time frame, back up 15 years because that's how long it will take to accomplish what is needed to fund your post-employment way of life.
Over the recommended 15-year period you should begin shifting assets from higher risk equities to lower risk fixed-income investments. In year zero minus 15 you should shift 1/15th of your assets in equities to fixed-income assets such as federal, provincial, and corporate bonds. In year zero minus 14 you should shift another 1/15th of your equities into fixed income.
The 15-year time frame leaves the bulk of your equities growing at a theoretical faster pace while making a gradual transition towards a reduced risk profile over an extended period. After 10 years you would still have a portion of your assets in equities while having shifted a large portion of your assets to fixed income.
The rationale for the focus on fixed-income assets during the transition to retirement is that as one gets closer to the end of work they need to better manage risk. Lower earnings power and a shorter investment horizon once retirement is reached increases the risk associated with exposure to equities. Simply put you don't have the income or time to make up for losses.
Another benefit of an extended transition period to retirement is that it provides an opportunity to structure a fixed-income ladder. A fixed-income ladder is a series of investments with staggered maturities. Each rung in the ladder holds a portion of a portfolio so that all of the assets are not exposed to reinvestment risk in the same calendar year.
Now that we have established a time frame for the transition to retirement, the appropriate asset class, and a portfolio structure, let's examine the outlook for yield.
The low rate of returns that today's retirees have had to endure on their fixed-income portfolios look to be coming to an end. Governments around the globe cut interest rates to paper over the economic consequences of the tech wreck of 2000, the terrorist attacks on the World Trade Center, and the Great Recession we have endured since 2007.
The forecast for interest rates is for a rising trend as central banks begin to wring the tsunami of liquidity, used to avert one crisis after another, out of the global economy. I often think of 1981 when interest rates in Canada peaked at close to 20 per cent and how savvy investors planning for retirement picked up fantastic yields for extended terms for many years thereafter.
They say that retirement comes at the end of your working life because it's the best part, and I can assure you that with a long planning horizon and some thought given to risk management it will be.
Happy Capitalism!
