Structuring your Portfolios for Withdrawals

For years, most commentaries have been focused on your portfolio strategies for accumulating capital to provide income for retirement. Now that the front edge of boomers, the largest demographic group to show up in history approaches age 65, many people will be facing the challenge of shifting their portfolio from a capital-generating growth machine to a cash-providing machine. Choosing how much income you can comfortably draw and deciding how to allocate assets to match your portfolio's income are going to be some of the most important investment decisions you ever make for your retirement portfolio. Your concern is that your capital does not run out before you do.

There will never be a time that the need for a qualified “Retirement Income Specialist” will be more important. The typical strategies for capital accumulation can be counter-productive when it comes to withdrawing money from your portfolio for income.

The first common strategy during accumulation is maintaining  a bias towards growth or equities. However, when it comes time to withdraw funds, one must lean towards more fixed income in your portfolio; reducing volatility is critical to maintaining your portfolio when making withdrawals. In fact, lower volatility can be more important than your rate of return when making withdrawals.

The second common strategy that works well when accumulating is “dollar-cost averaging”. When you are building or accumulating your portfolio, you invest equal amounts regularly over a period of time, usually monthly. By following this path, more shares are purchased when prices are low and fewer shares are purchased when prices are high. When accumulating capital, it is a very effective way to take advantage of the market’s ups and downs, because it gives you a lower average purchase price.

However when withdrawing funds, the dollar-cost averaging theory works in reverse. To keep fueling cash flow, you may end up selling more shares when markets are weak and fewer shares when markets are strong. Depending on how the market cycles unfold, if your income draw is too high, you may find your capital eroding significantly, capital that is not easily replaced.

You do have choices; product diversification can protect your portfolio. This is achieved by layering your sources of income using a combination of the cash wedge, GIC ladders, annuities and structured portfolios. With a structured portfolio, you can choose to be more conservative. We often refer to 5% as a rule-of-thumb that says by drawing 5% of your initial portfolio value indexed for inflation, you are in a better position to have a sustainable income level over a 30 year horizon, as stated by Moshe Milevsky in "A Sustainable Spending Rate without Simulation", which is from the Financial Analysts Journal 2005. You could expect a better return than 5% from your portfolio over time, but the impact of inflation and portfolio volatility needs to be accounted for when deciding on an initial spending rate. Even a 2.2% inflation rate would double the income needed over a 30 year period.

While it's important to view investor behaviour and wealth management portfolios, it's equally important to consider if you can live with how you envision retirement unfolding. Do you plan to work after your retirement? Will there be other sources of income? Does it make sense to consider “product allocation”,  the use of annuities and the cash wedge to layer different sources of income to protect your future? Along with CPP/OAS and income splitting opportunities and the use of tax-efficient products such as Corporate Class investments, you can continue to grow your wealth while making withdrawals.  A good Retirement Income Planning Specialist can assist you with these difficult questions.