Another complicating factor is placing a security in the context of growth. In the accumulation phase, it’s mostly about growth — to the degree the investor is not independently wealthy. But growth can play a role in retirement as well. To be sure, one could buy a ladder of real-return bonds to receive a fixed, after-tax income indexed to inflation. But spending in retirement departs from changes in the consumer price index in significant ways, especially when it comes to health care. Beyond that, many retirees will have as much as a third of their lifespan ahead. It is often overlooked, when it comes to early retirement, that a 60-year-old has a good chance of living well past the age of 90. It’s imperative to include this in retirement income calculations. And to make allowances.
This then broaches a topic that’s been extensively discussed in the U.S. and that now has made its way across the border: production allocation. That involves a matrix of equities and variable annuities (segregated funds with guaranteed minimum withdrawal benefits), fixed or life annuities and bonds. Ibbotson Associates — whose founders inaugurated the annual analysis of the returns to stocks, bonds and T-bills back in the 1970s — has made this a focus of research, and it is beginning to show up in equity markets.
This research offers interest prospects. There is, of course, the traditional trade-off between self-annuitizing through bonds versus a fixed annuity. But there is also the dynamic mixture of GMWBs with some upside equity exposure versus a straight equity element with a potentially greater upside — and downside.
Within equities there are other decisions to be made. Should it be a life-cycle fund, for example, whereby a portfolio is managed with a target date in mind? These are popular products in the U.S., particularly as the default option in a 401(k) program. There are a number of reasons for this. One is that employees may not enrol in a 401(k) program; even if they do, they may not make optimal investments, instead dividing money in equal amounts among each option offered. (Famously, Harry Markowitz, the founder of modern portfolio theory, from which comes the notion of an efficient frontier, did precisely this).
Beyond this is the question of what equities to purchase. What used to be considered blue-chip equities have proven naked against a swelling tide of non-confidence. Some Canadian blue-chips, however, have been spared. Why are they blue-chips? Mostly for reasons of stability — particularly the stability of the dividend.
Dividends are important for a number of reasons. To be sure, they are a mark of prudent management. And the discipline of having to make a regular dividend payment curtails corporate empire-building. Dividends, in addition, attract more favourable rates of taxation than ordinary income to relieve the burden of double taxation: first at the corporate level and then at the individual level.
But not least, reinvested dividends account for the vast bulk of the outperformance of stocks over bonds.
Just as each individual’s retirement path is unique, so too is the combination of options to fund it. There are some common tools: the trick is to put them together properly.
Finally there is the estate question. Ideally, a client dies broke after a long and happy life. The paradigm for this would be a reverse mortgage, drawing down accumulated assets very much like the lifetime earnings hypothesis. But many clients do want to leave an estate.
That may lead to a back-to-back or insured annuity: a life annuity whose income pays the premium on a life insurance policy.
 | Filed by Scot Blythe, Advisor.ca, scot.blythe@advisor.rogers.com |