Investing for retirement can be as easy as picking a handful of stocks, bonds and funds and hoping they age well. Investing effectively, though, can be a little more complicated.
To fund your ideal retirement, you need to earn the highest possible returns in a way that best mitigates risk. Achieving that can be a complex task when the economy is mired in uncertainty and more investment options are available than ever.
“The world of investing has become more complex in recent years,” says Mark Bayko, a portfolio adviser and vice-president with Royal Bank of Canada’s wealth management division.
No one wants to see his life’s savings disappear in a market correction, so on paper, the age-old asset allocation strategy of reducing risk as you approach retirement still holds up. But executing that strategy in 2014 is more multidimensional than owning more bonds and less in equities, or stocks, as you get older.
Today, “there are alternative asset classes that can complement your traditional asset class breakdown,” Mr. Bayko says. Investors should consider dedicating a small amount of their registered retirement savings plan (RRSP) to hedge funds, funds of funds and convertible bonds to reduce their portfolio’s volatility, he says.
Equities should make up the vast majority of a portfolio for young investors with a long time until retirement, Mr. Bayko says. Along the way, a static percentage of the portfolio should be made up of these alternative asset classes, while fixed-income assets such as bonds should be added later, reducing risk as retirement approaches.
Fears of a market correction have led investors to be skeptical of equities since the 2008 recession, but because interest rates have nowhere to go but up, some financial experts think bonds may not be a wise purchase right now.
Indeed, the idea of simply buying a bond doesn’t make sense in 2014, says Mike Newton, a portfolio manager and director with Bank of Nova Scotia’s wealth management division. He puts it bluntly: “I don’t think bonds will do well. You need to explore alternatives.”
He worries that investors are blindly turning to bonds because they still fear the equity marketplace after the recession, instead of considering the poor yields that bonds may bring in the next few years. “It’s difficult to get people away from what’s considered to be gospel,” he says.
Investors with at least 20 years left until retirement, Mr. Newton says, should avoid bonds completely – or at the least keep exposure to a minimum. They should hold about 5 per cent of their portfolios in cash, about 10 per cent in real estate investment trusts, and the rest in strong, dividend-paying equities, he says.
Even people in their 50s shouldn’t keep more than 10 per cent of their portfolios in bonds. And for those, he recommends looking for short-duration, corporate-bond exchange-traded funds (ETFs) in the Canadian marketplace.
Investors will be able to buy higher-yielding bonds in a few years once interest rates have risen, but in the meantime, Mr. Newton says, they should buy short-term bonds or roll short-term guaranteed investment certificates (GICs) into their portfolio.
GICs and other cash equivalents are an important component of another strategy that’s worth considering – they can be used as a safety net for people on the cusp of retirement who are ready to draw down their retirement savings.
Soon-to-be-retirees should have two to three years’ worth of savings in cash or equivalents, such as laddered bonds, giving them the freedom to draw down savings without losing value in their equity holdings.
“They can get cash quickly for withdrawal and don’t have to worry about a bad market,” says Barbara Garbens, a chartered financial planner and founder of Toronto’s B L Garbens Associates Inc.
Then they can wait out the market until it favours liquidating their equities. “They can draw [cash holdings] down,” she says, “and they don’t have to sell the equities if the timing isn’t optimal.”