Capital preservation is top of mind for most retiring Canadians. Yet, some financial advisors say investors are looking at the issue of funding their retirement through the wrong end of the lens.
Rather than ensuring they don’t run out of money, investors and their advisors should worry more about creating a steady income throughout retirement that keeps pace with inflation, says Darren Coleman, senior vice-president, private client group, and portfolio manager at Coleman Wealth, a division of Raymond James Ltd. in Toronto.
“Clients and advisors have long been using the wrong paradigm, and that is focusing on capital preservation and growth,” he says. “But the reality is the vast majority of clients seek to have a comfortable retirement.”
And to Mr. Coleman, that’s an income problem to solve.
Numerous studies published in recent years indicate that baby boomers are concerned about outliving their money. One from Royal Bank of Canada published in July found Canadians aged 50 and over worry about not having saved enough money to retire. What’s more, it showed that more than half plan to downsize their living arrangements to boost retirement income while a quarter noted the possibility of borrowing against their homes if needed.
Mr. Coleman isn’t the only expert who thinks an advisor’s primary role is to build reliable, growing income for what could be a retirement of 30 years or more.
“An investor’s need for consistent income is something we hear about regularly from advisors,” says Sanjiv Juthani, head of product management, investment funds, at Manulife Investment Management, which has a suite of income-producing investment funds for that very reason.
But providing income without significantly eroding capital is a conundrum for many advisors.
Mr. Coleman says he typically uses a portfolio of blue-chip dividend stocks, real estate investment trusts and mortgage investment corporations for his clients.
“By their nature, these increase dividends on a regular basis,” he says.
That’s important because the cost of living is likely to rise even faster than the average rate of inflation over time, Mr. Coleman adds.
And cash flows from investments must keep pace. Otherwise clients risk dipping into capital, which often accelerates over time because fewer assets are left to generate income.
“For the average person, their cost of living probably goes up between 3 to 5 per cent per year,” he says, noting food, rent and transport typically outpace the Bank of Canada’s target of 2 per cent inflation.
Consequently, investors who are in their early 60s today and need an annual income of $20,000 from their investments may need $60,000 a year when they’re in their late 80s.
Fixed-income investments that yield about 2 per cent obviously cannot meet this need, he says.
“So, the best hedge against rising prices is U.S. dividend-paying stocks.”
Daryl Diamond, advisor and founder of Winnipeg-based Diamond Retirement Planning Ltd., agrees that dividend-paying stocks have a role to play, but they have limitations.
“You basically need a pretty big stack of cash [to invest] to only live off the income,” says Mr. Diamond, whose practice focuses exclusively on ensuring near-retirees and retirees have the proper retirement income planning in place.
For example, he says that even a $500,000 portfolio yielding 4 per cent – a high average yield from a dividend portfolio – will only generate $20,000 a year in income.
That may work well for clients who also have defined-benefit pensions that, along with Canada Pension Plan and Old Age Security, provide a solid foundation of steady income. But, increasingly, clients have no workplace pension plan or they have defined-contribution plans that offload the problem of generating enough assets to retire on onto them, says Kirk McMillan, regional vice-president, wealth distribution, at Sun Life Financial Inc. in Toronto.
“So, advisors are left with having to solve for growth. They also have to solve for income, and now they have to solve for protection of income as well,” he says.
Mr. McMillan adds that many advisors look to segregated funds, which provide a combination of strategies such as guarantees on income, protection of capital and the ability to defer payments.
“As far as the different products are concerned, advisors have a lot of options,” says Meghan Meger, regional president, Prairies region, at BMO Private Wealth Management, in Calgary.
And many advisors are looking to managed solutions for income.
“That’s because the ability of an individual advisor to assess the number of investments at any great length is almost humanly impossible because there is so much choice,” Ms. Meger says.
She further notes one increasingly common option is a managed portfolio account that takes portfolio construction and management out of advisors’ hands.
“That way, the advisor can be objective and substitute when necessary different (managed product) programs or different managers to fulfill the income need,” Ms. Meger says.
And if a strategy falls short of goals, “the advisor fires the solution rather than the client firing the advisor,” she says.
Indeed, income strategies should be driven by investors’ goals, Mr. Diamond says. Lifestyle needs are one consideration. So, too, is legacy. To some, ensuring a rising income over time is less important than leaving money for adult children – and they adjust their lifestyle needs accordingly.
“Then, there people at the other end of the spectrum who say, ‘The house may be here when I go, and they can have that, but I’m spending this money and everything in between,’” he says.