When you think ahead to your retirement, which could last 25 years or more, you probably don’t see yourself doing the same thing in the same place the whole time. You might be very active, travelling or fishing or playing golf, for some of those years. And you’ll likely be more inclined to take it easy for some of the time, as well.
In the same way, your retirement portfolio shouldn’t be unchanging over the years. The funds you’re saving to see you through your non-working years should be invested differently at different stages leading up to your retirement, and after.
“If you’ve got a financial plan and you’ve started saving, the question is, what do you invest in to make sure you get your nest egg to the size it needs to be?” Steve Shepherd, Vice President, Investment Strategist, BMO Asset Management, says. “And how do those investments need to change over time?”
15 years from retirement
The further a person is from retirement, the more risk they can afford to have in their portfolio. That’s because, if they experience a loss 15 years away from their planned retirement date, they have more time to make it up than if they were going to retire, and stop contributing to their retirement fund, in just a year or two.
“With a longer time horizon, typically you can tolerate a little bit more volatility in the day-to-day value of your portfolio, which typically means a higher equity exposure,” says Shepherd, who is based in Toronto. “The value of being invested in equities is that, over time, they tend to outperform bonds, on an inflation adjusted basis, contributing to the total compound rate of return that you’re looking for. Additionally, equities provide an inherent inflation hedge, which is critical to protecting the buying power of your savings.”
5 years from retirement
When you’re within five years of your planned retirement date, your portfolio needs to be a lot more conservative, less weighted toward equities and more toward fixed income.
“As you get closer to retirement, you have to be thinking about protecting what you’ve already earned,” says Shepherd, noting that this is where people’s emotions can get in the way. If the markets are doing well and equities are providing double-digit returns, it can be frustrating for some people to have a portfolio that’s designed for wealth preservation, holding less in equities and more in lower-returning assets.
“However you have to realize that your personal asset mix is like a prescription for your portfolio, designed specifically for you because you’re five years away from retirement. If you’re fully exposed to the equity market, you’re also fully participating in the potential shorter-term downside associated with the equity market.”
Retirement and after
After you stop working, and you’re drawing on your savings rather than adding to them, you’ll need to make sure your assets are protected but still keeping up with the rate of inflation.
“A lot of people have built their retirement plan around an assumption of two-per-cent inflation,” Shepherd says. “But that’s not the long-term historical average of inflation. I think people need to take into account what happens if inflation goes to four per cent of even five per cent, and seeing what that does to their retirement plans.”
Shepherd recommends working with a financial advisor to determine the best portfolio mix for you at every age and stage on the road toward retirement.
“There’s the accumulation phase, the transition phase and the spending phase in any retirement plan,” Shepherd said. “All three of those need to be looked at together by someone who can test out scenarios and push back if the client tends to let their emotions take over.”