The ever-populist Francophone economics columnist Michel Girard wrote this morning that the Trudeau government should allow retirees to not withdraw from their their RRIFs or LIFs this year because of the markets’ collapse. In fact, the federal government already reduced retirees’ minimum required withdrawal amount. The goal, of course, is to allow them to “rebuild” their portfolios before withdrawing money again.
Every time I read this, I feel a twinge in my heart, and this text will help you understand why.
SOME CURIOUS RETIREMENT STORIES
There are plenty of stories about people being suggested by friends, sometimes even their advisor, to stop withdrawing money from their investments in order to bounce back more quickly as the market recovers. However, some of these people are retirees who need the retirement income to make ends meet. Furthermore, it can be a great source of stress for them to think they have to change their plan because of the crisis.
VotreConseiller.net advisors have always been trained to apply a key principle in their management of retirement income disbursements – what we call the two-fund principle.
NEVER SELL LOW
One of the basic principles of stock market investing is surprisingly easy: to make money, assets should be purchased when their value is low and sold when their value is high – a mantra that we keep repeating to all our clients who are building wealth and don’t need their assets in the short term. “Be patient, it will go back up, you’re not withdrawing for 20 years.”
It is based on this logic that retirees are being advised to not sell anything right now. However, a pension portfolio is not, and should never be, made up of only equity holdings.
THE PRINCIPLE OF HAVING TWO PENSION FUNDS
Significant portfolio changes are typically necessary during the pre-retirement stage. Since disbursements are expected in the near future, we need to make sure that we can sell assets when they are high, not when they are low!
That is the rationale behind the principle of having two pension funds. We build a short-term fund and a long-term one. The long-term fund consists of mostly the same assets the retiree had prior to retirement, based on their risk tolerance, and enables them to get the best possible return in the long term. This fund includes all the assets that will be withdrawn in seven years or more, depending on the retirement projection.
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Then, all the short-term assets – the ones that will be withdrawn in the next six years – are consolidated into what we call the short-term fund. For this fund, we choose very safe assets that will not lose value during crises. The goal here is to buy time for our long-term assets.
THE SHORT-TERM FUND
The short-term fund brings together a wide variety of assets, such as high-yield accounts, guaranteed investment funds and bonds, depending on where in the economic cycle we are.
The important thing here is to protect the capital – the assets that will be disbursed in the short term. The return expected is necessarily lower.
It should also be noted that a pre-retiree who is waiting for a significant influx of cash following the sale of a property or a business will have their short-term fund set up once that cash comes in.
During this crisis, all our clients who had a short-term fund in place saw their assets protected. They can therefore continue withdrawing based on their initial plan, as though nothing happened.
The short-term fund is there to make sure that we never have to sell assets low. It also offers retirees peace of mind. The short-term fund renders moot using not only the measures proposed by Michel Girard, but also the measures already implemented by the Trudeau government with respect to RRIFs.
ANNUAL REBALANCING
We generally meet with our retiree clients at least once a year to rebalance their portfolio.
In addition, we suggest that retirees keep an amount equivalent to six months of income in their bank account. Then, monthly retirement income is paid out according to a very specific plan by selling short-term assets.
So, if we had started the year with an amount equivalent to six years of revenue in that short-term fund, we would end it with the equivalent of five years.
In years when the stock market does well, we sell assets from the long-term fund that are up in value in order to buy the equivalent of a year’s income in the short-term fund and replenish the disbursements made. The idea is to maintain our financial security cushion.
WHAT ABOUT WHEN THINGS GO WRONG?
When the stock market is in bad shape, as it was in 2020, there is no rebalancing. We don’t sell any shares from the client’s long-term fund. We only sell safe securities from the client’s short-term fund that haven’t gone down in value. And we can do that for six beautiful years, giving the long-term fund time to “rebuild” itself.
Eventually, once the storm has passed, we can rebalance the client’s portfolio and re-establish their six-year financial cushion. It’s a multi-year process.
What you must remember is that this type of management achieves three core objectives:
• Never sell assets that are sharply down in value
• Stick to the initial plan
• Avoid unnecessary stress for the retiree
AN EFFECTIVE STRATEGY
In short, this strategy may seem complex, but once it’s properly explained and, most importantly, applied, it allows retirees to better manage their emotions in times of crisis.
Our retiree clients’ stress is greatly reduced these days when we tell them they can continue to receive their payments as expected, and even more so when we tell them the sold assets increased in value since January 1, 2020!
