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Retirement

Don't be snowed under by the sequence of returns Add to ...

There is a great deal of academic research that states that the sequence of your investment returns is a significant determinant of whether you outlive your money in retirement. This research has been used by many investment firms to sell particular products, most specifically the Manulife Income Plus product. To see how the sequence of returns "technically" affects retirement income, visit their Sequence of Returns calculator.

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The reason that the math works is that if you are drawing out 5 per cent of your savings a year, then your asset base will likely decline over time (depending on overall returns). As a result, the investment returns that happen in an earlier year will affect a larger pool of money, and the investment returns that happen in a later year will affect a smaller pool of money. As a result, if good returns happen first, you are better off than if bad returns happen first.

While the math is all true, the solution isn't to pay high fees for a guaranteed income product. The investment reality misses a key principle.

What is missing is the fact that after a year or period of poor investment performance, the market will overcompensate with stronger-than-average returns to get back to its "normal" level. What this means is that as long as you stick to your investment discipline, you will get better investment performance after poor performance, and it will then carry you back on target.

The most recent example has been 2008, 2009 and 2010. Based on the sequence of returns research, if your last year of work or first year of retirement took place in 2008, then you are the unfortunate loser in the game of sequence of returns. According to the investment industry, the solution is to invest a lump sum in a guaranteed product with high fees that will get charged every year of your retirement, so that you can avoid this terrible situation. What actually happened is that after the TSX total return index returned -34 per cent in 2008, it has averaged 25 per cent returns over 2009 and 2010. Of course, if you invested in a guaranteed withdrawal benefit product, you wouldn't have been able to invest in anything more risky than a balanced portfolio and you would have missed much of the strong returns of the past two years.

What the real message should be is: Don't pull your money out of the market after it falls 20 per cent. Better yet, if you have other investments, it might be time to add to your stock position once the market drops 20 per cent.

There are a number of other historical examples to support the reality that isn't taken into account in the sequence of returns research. Using the bear market rule of thumb, there have been five periods of 20-per-cent declines or more on a rolling three-month basis since December, 1985 - not including the 2008 example above. Using TSX composite numbers, the investment firm CPMS provided the following research:

One year later, the average total return was 14.1 per cent. Five years later, the average total return was 37.6 per cent. However, by trying to time the market and missing the returns in year 1, the five-year return falls to 22.8 per cent.

With our clients, we generally have an asset mix range. An example might be a range from 50-per-cent to 70-per-cent stocks. Based on the market cycle, we will adjust that weighting somewhere between 50 per cent and 70 per cent, but we maintain the discipline to always stay invested within that range unless there is a meaningful change to a clients' situation that would require an adjustment to their asset mix. We don't go outside of that range based on the market.

The key to investment growth is to have some long-term discipline, understand the risk vs. reward tradeoff you are making, be tax smart with your investments, and while working, try your very best to take advantage of TFSAs, RSPs, RESPs and matching pension programs through your employer.

The key to poor investment performance is to pay exorbitant fees for unnecessary guarantees, to jump into the market after the good performance has already happened and to jump out after bad performance, to miss out on the government and corporate gifts that come along during your good earning years, and to take too little risk by investing long term in GICs.

To keep it really simple - if an investment product has a lot of fancy brochures, charts and binders produced by the manufacturer of the product, it clearly means that this is the product they are pushing. They don't push products that make them little money. They only push the ones with the big margins. The fancier the package, the faster you should run.

When it comes to the sequence of returns affecting your retirement income, remember that even after a rough winter, spring always comes.

Follow Ted Rechtshaffen on Twitter: @TriDelta1

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