For investors with a strong constitution, the current market malaise may very well represent some “good buying opportunities,” as described by Prime Minister Harper. For Canadians planning to retire within the next few years, the situation holds far less promise. However, new research suggests that a few changes to one’s portfolio mix can protect against sequential risk and prevent retirees from outliving their wealth.
The study, by Russell Investments, has found that a mix of 35% equities with 65% fixed income is among the most effective strategies to protect against sequential risk.
“One of the biggest concerns that investors are facing this very moment is the ability of their portfolios to withstand negative portfolio returns in the five years before retirement or in the first few years of retirement when withdrawals are made,” says Irshaad Ahmad, president of Russell Investments Canada.
“This concern is otherwise known as sequential risk: The risk of receiving lower or negative returns early in a period when withdrawals are made from the underlying investments.”
Ahmad offers an example of three portfolios, each with a starting balance of $1 million and an asset mix of 60% equities and 40% fixed income, with return expectations based on Russell’s long-term capital market forecasts. The portfolios have a withdrawal amount of $50,000, indexed at 3% annually.
The study applied return rates to each portfolio, although the returns came in different sequences. After a dismal return of -15% in the first year, Portfolio A was wiped out within 27 years, while the other two, both with better returns early on, continued well past the 30 year mark, despite poor returns at the later stages for Portfolio C.
This scenario is typical of what some clients may be facing right now, explains Ahmad. “Although all three portfolios averaged a 7.4% return over 30 years, Portfolio A had a value of $0 at the end of the 30 years due to the negative returns (-15%) it experienced in the first year of $50,000 withdrawals,” he says. “In fact, Portfolio A only lasted 27 years, increasing the likelihood that a client faces longevity risk by outliving their investments.”
He explains that the stark difference in the ending values of each portfolio should help clients realize the likely prospect that their nest egg might be decimated by the current market volatility without professional financial advice.
“Conservative portfolios of 100% fixed income and 100% cash provide stability but little in terms of longer term growth and may not last throughout your retirement years,” he says. “On the other hand, the 100% equity portfolio achieves higher long-term growth, along with much higher risk and uncertainty.”
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