Helpful miscellaneous articles
regarding our retirement plan and planning.
Like you, I review my retirement nestegg and plan from time to
time. Recently, I went though some
continued education for some credentials I maintain and it occurred to me that
we all could use a review about these issues.
So with your help, we will share and post articles and info that may be
helpful and of interest to many of you in this section.
What should retirees do
with their investments amid COVID-19?
With North American
stock markets down more than 30% from their recent highs, Canadians who are
retired or close to retirement are faced with a choice—to sell or not to sell?
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The speed and severity of the decline in global stocks and
the potential for further losses have a lot of people wondering if they should
sell now and protect their retirement savings. Canadians who are close to
retirement or recently retired are particularly at risk. There is a risk that
stocks could fall further. But there is also a risk that selling now means an
investor may not recoup their losses when, not if, stocks recover.
Let’s start by summarizing what we know about the current
situation, and the historical context. The Toronto Stock Exchange is trading at
the same level it was at in March 2006—14 years ago. In the U.S., three of the
largest 20 daily percentage changes in the S&P 500’s almost 100-year
history have occurred this month. Global stocks, as represented by the MSCI
World Index, are down more than 20% year-to-date.
Interestingly, the Chinese stock market—the Shanghai Stock
Exchange Composite Index—is down 10% year-to-date, making it one of the best
performing stock markets.
According to Invesco, the average bear market since 1957 has lasted just under
12 months, and the average loss has been 34%. In 1929, at the outset of the
Great Depression, U.S. stocks took 30 days to fall 20% and enter a bear market.
This recent downturn took only 16 days—the fastest bear market in the history
of the S&P 500.
Before deciding how to react to the current COVID-19 fuelled
situation, it is important to consider the math behind stock market declines.
If stocks fall 10% five times, you would think they would be down by 50% (10 x
5). In fact, they would be down 41%, because each subsequent loss is based on a
lower starting value. I know that may be of little consolation, but the math
gets better.
If you have a balanced portfolio of 60% in stocks and 40% in
bonds—a common, moderate-risk asset allocation—a 30% decline in stocks might
decrease your portfolio value by 18%. Once again, that may not be enough to
ease your fears.
What about considering what tends to happen after
stocks fall 30%? Ben Carlson of Ritholtz Wealth Management wrote a great post about the 12 previous bear markets that have been worse
than the current U.S. stock market decline. He notes the average 1-year return
from the market’s bottom has been 52%, and even the worst 1-year return has
been 8%. We do not know if we are at the bottom yet, of course, but the point
is that stocks tend to perform well in the year following a large decline. The
average 3-year and 5-year returns have been 89% and 132% respectively.
What this tells us is that even
though stocks could be lower a year from now, there is a reasonable likelihood
they will be higher in the medium term, and the longer your time horizon, the
more likely stocks will be higher (and even much higher).
If you own an individual stock, particularly shares of a
small company, it is possible that one company could go bankrupt and its share
price could go to zero. If you own a diversified portfolio of individual stocks
directly, or indirectly through a pooled fund, mutual fund or exchange-traded
fund, keep in mind the stock market itself will not go to zero. Despite any
potential criticisms of capitalism, it is good at making money.
This stock market decline may or may not mean you need to
reconsider your retirement date, potential spending in retirement, or other
factors. But the same could happen if you lost your job, had an unexpected
illness, or had to lend money to one of your kids because they were going
through a divorce. Retirement planning and financial planning, in general, are
fluid exercises that require revisiting and revision.
If you are within a couple of years of retirement, the good
news is you probably will not need any of the money in your investment
portfolio for a couple of years. And even then, you may only need to withdraw a
small portion of your investments within the first few years of retirement.
If you are already retired, hopefully your investment
withdrawals are no more than 5% of your portfolio value, and hopefully less,
but can differ depending on individual circumstances. The TSX is yielding about
3% right now, the S&P 500 is yielding about 2.3%, and the FTSE Canada
Universe Bond Index is yielding about 2%. Dividend yields and interest rates
could fall, but 2% to 3% or more of your required withdrawals may come from
income as opposed to from capital. If you are only going to need to sell a
small percentage of your stocks over the next few years, the bulk of your
investments has time to recover.
I have a client who, despite my hesitation, sold all their
investments this week and put the proceeds into a GIC.
I worry that may turn their temporary losses into permanent ones, and their
potential future investment return given today’s historically low interest
rates is virtually nil. Regardless, it was the choice that made the most sense
to them.
We had a MoneySense reader ask about cashing in their RRSP and putting it all into a GIC
in their TFSA. Not only would this result in the same guaranteed loss
with low future return potential, but it would trigger unnecessary income tax
payable on their RRSP withdrawals—a double whammy.
One of the risks of knee-jerk
reactions at a time like this is not fully understanding the repercussions.
Investing involves taking on risk, but with a diversified, risk-appropriate
portfolio, it can be an educated risk. There have been 16 bear markets during
which stocks have fallen 20% from their peak since 1926, an average of about
once every 6 years. Stocks were always going to fall 20% or more at some point.
If it had not been for COVID-19, the fall may have happened in 2021 and it may
have taken a year instead of a few weeks. The point is that this was bound to
happen. And this will not be the last time.
Retirees with Registered Retirement Income Funds (RRIFs) can
take some solace in the fact the federal government announced this past week
that RRIF minimum withdrawals have been reduced by 25% for 2020 as a temporary
measure. This may reduce the required sales of depressed stocks for retirees,
but will not help much for those who need their RRIF withdrawals to live on and
who cannot afford to take out less.
Young investors should consider this recent stock market
decline a buying opportunity. Stocks are on sale, and there may be 5 to 7 more
bear markets like this for a 25-year old between now and retirement. Expect
this to happen again.
The stock market volatility this month and the speed with
which stocks have fallen is really concerning to everyone, including me, both
as a financial planner and as an investor. Stocks are leading indicators and
reflect expectations about future corporate profitability and the economy.
Stocks are already pricing in a recession, and by the time the economic numbers
(many of which are lagging indicators) confirm a recession, stock markets may
already be on the rise again.
So, although stocks may still fall further from this point,
they literally cannot fall forever. Stocks will recover, as will Canada and the
rest of the world.
This is a scary time to be an investor, and an even scarier
time to be a business owner, an employee, a politician, a health care worker, a
parent or a child. My mother used to tell me “this too shall pass.” Sometimes
it is hard to believe that when you are in the thick of things, but I caution
investors from making rash decisions with their investments at a time when it
may be difficult to envision the long-run implications.
Jason Heath is a fee-only, advice-only Certified Financial
Planner (CFP) at Objective Financial Partners Inc. in Toronto. He does not sell
any financial products whatsoever.
(As with any of these informative articles,
anyone who needs someone to talk to about
this
very subject contact me and I can direct you to a knowledgeable advisor).
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