With Canada’s population aging at a rapid rate and demographics shifting, having enough income in retirement is becoming a key concern for investors.
Eight million Canadians will be over 65 by 2026, and 20% of the population will be spending on average 25-plus years in retirement. Retirement wealth is expected to grow to $5.45 trillion by 2030; the 55-plus age group will account for two-thirds of Canadian financial wealth (excluding real estate) 1.
While this is clearly a lot of money, this doesn’t mean that all of those eight million retirees will have a comfortable retirement. There has been a long and continuous decline in defined benefit pension plans (particularly in the private sector), and Canadians now have to rely more than ever on their savings to provide income in retirement.
As retirees make the move from contributing to their savings to withdrawing from them, they are suddenly faced with a balancing act between withdrawal levels, capital preservation, a need for growth, tax efficiency, estate objectives and risk management. Withdrawing from retirement savings requires a drastic change in investing priorities.
The three pillars of retirement portfolios
When you move into retirement, priorities change and there are three key pillars to consider: providing income, downside mitigation (managing risk during market declines) and inflation protection (growth). During the stage when investors are building their nest egg, they naturally focus mostly on growth. However, this focus shifts to capital protection as they approach and enter retirement.
During the saving years, downside market volatility can be used to the saver’s advantage through ongoing deposits when markets decline (dollar-cost averaging). Once retired, with no regular salary coming in, it becomes far more difficult to contribute to retirement savings and replace any investment losses due to market downturns. In fact, these losses can be locked in if you’re forced to sell some investments to provide income.
Here’s how those three pillars break down:
Providing income
Given that government pensions fall short by close to $23,000 per year for the average retiree’s needs,
anyone without a defined benefit pension plan or company pension, would need to have substantial savings to compensate for this shortfall. Additionally, they would need to draw an adequate amount from their savings to ensure enough income, without their savings running out.
We estimate that a retirement portfolio needs to generate a total return of between 4–7%. With 10-year rates hovering around 1.5%, a retirement income portfolio consisting of only fixed income is unlikely to be feasible. Successfully building a well-diversified portfolio to balance these risks and deliver this kind of return will make the difference between a comfortable retirement and a financially stressful one.
Downside mitigation
Protecting their savings from downside losses is extremely important for retirees who don’t want to see their savings run out at some point. With increased life expectancies, this is a common concern. The current, historically low interest rates provided by bonds (among the safest investments for retirees) means those retirees seeking income could find this to be a difficult situation.
Not long ago, obtaining the necessary returns was far more straightforward. In 1995, for example, you could have a portfolio of 100% bonds and expect a return of 7.5% with volatility of around 6%.
For illustration, now, to have the same 7.5% return, a portfolio would need to have three times the expected volatility (18%2) and would need to include real estate, private equity and global public equities, as shown below:
