Who needs stocks? A case for GICs.

This is the basic strategy (except using bonds, not GICs) espoused by the authors of Your Money or Your Life.

I do think there's a certain amount of "inflation proofing" that we can do to help reduce the impact of inflation and live on less. And it's true that paying off the mortgage removes probably the biggest expense we have in our working years.

Still, though, it's worth going through old magazines and catalogues and looking at prices from 20 years ago, comparing them to what they are now, and projecting that forward 20-30 years or to whatever point in the future we plan to retire.

If you consider that a pair of shoes that costs $80 today might cost, say, $250 in 20 years, and even a used pair of shoes might set you back $150, you start thinking it's worth taking on some risk in order to be able to beat inflation so you don't have to walk around barefoot. Or maybe you could buy a bunch of shoes today and keep them in a closet, waiting for your retirement. That doesn't work so well for other things, though, like milk.

lb71 said:

In today's Globe and Mail.

That's my parents right there. After last year's market meltdown, I had to wonder if they were on to something.

Edit: This should have been posted in Investing. Can a moderator move it?

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Mr. Trahair is just plain wrong. He is using one time period when stocks have underperformed bonds to make his case. GICs don't always beat stocks. For some time periods, their real returns have been extremely poor. There are two problems with a GIC only strategy:

1. Since expected real returns from fixed income instruments are low, an investor needs to save a lot more. It is true that with stocks realized returns could turn out to be low. But with fixed income, your expected returns are low to begin with and you have to resign yourself to live on less or work part time or retire later or a combination. What was your Plan B with stocks becomes your Plan A with bonds.

2. The risk in GICs / bonds is seldom discussed but there is a big one -- inflation. Bond yields are priced based on expected inflation. If actual inflation turned out to be far worse, watch out -- the returns could turn out be nightmarish.

Mr. Trahair makes some valid points. I think his suggestion to fully pay off the mortgage before investing has a lot of merit. I have no quarrel with his suggestion not to borrow against home equity and caution against leveraged investing. But I think, he is way off base in recommending avoiding stocks altogether.

There has been a tremendous amount of academic literature on this point in the last few years, and I don't think it has necessarily filtered down to the non-academic world. (Disclaimer: I haven't read Trahair's book.)

There are a couple of issues. First, the issues in accumulation and decumulation (retirement) are quite different -- decumulation involves the variable not just of investment returns, but withdrawals (this is the "sequence of return risk").

What this means in more practical terms is that for accumulators, the standard deviation of a portfolio is less important than for decumulators. It is only with decumulation (portfolio withdrawals) that sequence of returns risk enters the planning horizon.

In a generic discussion of "who needs bonds?" I am not clear that people are talking about accumulators, or decumulators; or whether they are not distinguishing between the two.

The general problem is thus: a retiree who takes on "too much" risk in the form of equities runs the risk of running out of money if markets perform poorly in the first few years of retirement. But a retiree who invests "too little" in the equity markets runs the same risk but at this time because there is too little investment growth to sustain the spending rate.

It is clear that for a portfolio with sufficiently low withdrawals (as a percentage of the total portfolio), an all-fixed-income strategy holds the least risk of running out of money -- but beware if you live longer than expected!

Unless you can meet your income needs with a very low withdrawal rate (i.e., under 4%), the optimal portfolio allocation *will* include equities. This has to do with both sequence of returns risk and inflation protection (as outlined above).

If you cannot tolerate stock market risk on an emotional level don't invest in equities.

If you cannot tolerate a permanent loss of capital don't invest in equities.

Save with Government of Canada Real Return Bonds, you will beat inflation by ~ 2 % consistently without any risk. You could also add a 5 year ladder of guaranteed GICs.

For most people securing a life-long retirement income & maintaining their lifestyle is the purpose behind the investing.

You can and should do something about stock market risk and the other risks you face as an individual. You can export that risk.

For the distribution phase, people who want the risk free and hassle free utility of GICs and the inflation protection of RRBs would do well to consider an inflation-indexed life annuity instead. It works like your MP’s inflation-indexed pension plan and will provide a higher cash flow (retirement income) than you could draw from ladder of RRBs.

In retirement using an inflation-indexed life annuity to make-up any income shortfall is a simple, safe and appropriate strategy for anyone with a normal life expectancy. It is also guaranteed for life.

I believe an evolving mix of GIC’s, RRB's and later in life an inflation-indexed life annuity would be especially appropriate for anyone averse to taking stock market risk. In fact, I’ve come to believe most people should adopt this strategy, to protect themselves ... from themselves.

IMO, the main points are:

1. You don't have to take stock market risk with your savings. You can beat inflation by 2% with out any stock risk at all using RRBs. You can also do well with a 5 year ladder of GICs , especially if you pick-up better rates (typically 1% or more) by working with a Registered Deposit Broker .

2. Using stocks to finance your retirement is much riskier than you have been lead to believe.

You insure you home against very low probability events like fire because the consequences are so enormous. We need to think about retirement planning in the same way.

It's not about trying to be Warren Buffet, Ben Graham or John Bogle, at least it shouldn't be.

This is about safely "Living a life of Wealth", your ability to do what you want, when you want and how you want.

You have very focused needs that require safe, suitable and guaranteed solutions. You don't need nerves of steel, machine-like discipline, world class investing prowess or even luck.

During the distribution phase (retirement) individuals cannot assume the risks the way a pension fund does and be successful.

Be very careful, IMO the conventional wisdom is wrong.

www.yourwealthadvisor.ca/.../3860207-three-crucial-tips

http://www.yourwealthadvisor.ca/apps/videos/videos/view/3860143-i-love-the-stock-market

http://www.compositefinance.com/investmentprinciples.htm

In fact if you want to invest in equities you should actually save more than you would using using RRBs. Why, because the potential distribution of returns is so wide. Only after-the-fact will you be able to determine if you could have saved less employing equities. By that time if you are "unlucky" it will be too late to help yourself.


Graham Cook

Composite Finance Inc.

Yes but: this strategy *only* works if you can earn enough with GICs to meet your income needs in retirement. The suitability of this strategy goes down -- way down -- as income needs in retirement go up.

For a 65-year-old male retiree with $1M (leaving tax aside for a moment) and a 30-year-retirement who can live on a 3% return (assuming 3% inflation and 3% returns), the probability of running out of money is 0%.

But if that retiree wants or needs, say, $60,000 from that portfolio, they stand a 24% chance of running out of money -- and 41% at $70K and 53% at$80K.

There are two parts to this equation. If you want to avoid stock market risk you must be satisfied with lower expected returns and lower income in retirement. (In fact, your expected returns may actually be negative if you use GICs exclusively -- see this study.)

Annuitizing (instead of putting it in GICs or RRBs) does not increase your expected income but will lower it - it protects against longevity risk. You can get a higher return from an annuity, but only in exchange for taking on some of the credit risk of the issuer; in addition to the loss of liquidity and any bequest potential.

There are not easy answers to this issue. A message of "GICs only!" or "don't exclude equities!" is not sufficient. I do not think the quality of this discussion (not this discussion here, specifically, just in general) is very high.

OK, I think I get a bit hotheaded about these issues and I apologize if my tone seems argumentative.

It seems to me that in general discussions of this topic, insufficient attention is paid to the fact that if you want to have only GICs, RRBs and annuities in your retirement portfolio, you must save enough pre-retirement so that you can live on the income from an all-GIC, RRB and annuity portfolio.

The question, to my mind, is not "are equities bad?" but "what is the least amount of risk I can take, given my income needs/wants in retirement?" and then find the optimal portfolio (while taking into account survival probabilities, and expected returns by assets class, and inflation). For some people, that may be an all-GIC/RRB/annuity portfolio. However, for many people (looking at the data about how much Canadians save for retirement), that kind of portfolio will be insufficient.

Do I think that equities have been oversold? Yes. But a wholesale swing back to guaranteed products is not necessarily a better strategy.

FeeOnly.ca said:

If you cannot tolerate stock market risk on an emotional level don't invest in equities.

If you cannot tolerate a permanent loss of capital don't invest in equities.

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I completely agree with these statements. Even so, I have to continually remind myself not to take on more risk than necessary. I'm always using financial calculators, not to see how much I can make should I luck out at a 15% annual return, but how I can reach my objectives and targets with the minimum risks possible.

As I get closer to my objectives, my weight in equities have been steadily decreasing...the risks are just not worth it.

Those of you with just a few years investing experience will find it hard to understand - especially in the internet age where it's simple to pull up financial reports, internet blogs, cheap advice ... whatever. The lure of equities is like a siren's song - it's in the media, news, everywhere...and everyone has illusions of being the next Buffet and retiring at 45. But if you lived through '81, '87, '91, '01, '02 and '08/09 you know what I mean. You coast along thinking you are bullet-proof and that you will win out because you are in it for the long run and wham, 50% of your hard earn money evaporates....my goodness - earning 12% the last five years don't look so great anymore. I've seen enough dreams destroyed that it's no wonder most of the older folks I work with have no more than 15% or so in stocks. They've been burned and simply won't get back in and put their future on the line...

I did qualify my remarks, but I understand that bad news is ... well bad news.

I also know this is a very unpopular viewpoint. But .. Hear me out.

The markets honestly don't know or care what any-body's income needs are, and there isn't a magic "asset allocation" for every persons income need.

In the distribution phase if you want to invest in equities you should actually save more than you would using using RRBs. Why, because the potential distribution of returns is so wide.

Only after-the-fact will you be able to determine if you could have saved less employing equities. By that time if you are "unlucky" it will be too late to help yourself.

If you want to learn more about distribution income planning, and see the actual math that illustrates these critical issues I highly recommend you visit Jim Otar's site and read the last 150 pages of his free online book here:

http://www.retirementoptimizer.com/

I'd welcome a discussion on the finer points of why equities may well be inappropriate but until you actually study the topic in depth I'll have an unfair advantage.

Or, for a few quick examples you can just review the ppt presentation below:

http://www.retirementoptimizer.com/Updates/AFreshLook.ppt

"How to read the analysis: The green line shows the asset value of the top decile portfolio since 1900. That means only 10% of portfolios ever achieved or exceeded the asset values indicated by this green line. Do not use this for your retirement planning; it is there just to show you what can happen if you are lucky.

The blue line shows the asset value of the median of all portfolios since 1900. That means 50% of all portfolios had a lower value and 50% had a higher value than this line. And where it crosses the zero line (meaning no money left in the account), it means that half of the portfolios have already run out of money. Do not use the median for retirement planning because the odds are not on your side.

However, the median line may have one useful application for estate planning: When I am estimating the tax liability or the insurance needs at the time of death, then I use the median. In addition, I use the green and blue lines for best and worst case projections, respectively.

The red line shows the asset value of bottom decile portfolio value since 1900. It indicates the portfolio value where 90% of portfolios survived and 10% are depleted. This is the line you need to use for retirement planning. That is because at 90% survival rate, the odds are on your side. If this line does not touch the zero line until your age of death, then you have an good retirement plan."


Respectfully,

CanadianCapatalist, the example portfolio is 40% Equity & 60% fixed income, not 100% equities.

Please read further, RRB are well considered in Jim's book.

IMO, incorrect asset allocation assumptions that don't work during distribution are very risky.

The typical retiring boomer needs guaranteed tools like GICs, RRBs and Inflation Indexed Life Annuities precisely because they are "on their own".

http://www.yourwealthadvisor.ca/apps/videos/videos/view/3860113-you-re-on-your-own

http://www.retirementsolutionscentre.ca/en/ProductAllocation/immediate_annuity.html

Respectfully,

What I do have a quarrel with is the suggestion to avoid stocks altogether


I'll qualify when I think it is appropriate to avoid stocks altogether.

You should avoid stocks altogether if any of the following apply:

1. You cannot tolerate stock market risk on an emotional.

2. You cannot tolerate a permanent loss of capital.

3. Your capital to income-need ratio is 33:1 or less at retirement. Then make-up any life-long essential income shortfall using only guaranteed products (avoid stocks altogether).

4. You are not 100% sure you won't act irrationally based on greed or fear, ever.

Put another way:

If your capital to income-need ratio at retirement is above 33:1, you can tolerate stock market risk on an emotional, you can tolerate a permanent loss of capital and you are not prone to emotion based decision making then .. go ahead and invest in stocks. But only up to 40% or 50%.