Interest rates are low, the stock market is volatile, and inflation is strong. As a result, boomers face many threats when it comes to their investments.
“You have a triple whammy of issues making it hard for someone in retirement who doesn’t have a pension to generate some safe income,” says Joel Clark, managing partner at KJ Harrison in Toronto. The impact of the financial crisis of 2008-2009 is financial repression; hence, you’re killing the savers.”
Those savers, then, must put more money into instruments that will generate returns higher than inflation—equities. Yet many find that unpalatable.
How do you persuade them?
Scott McKenzie, regional vice-president and general manager at T.E. Wealth in Toronto, encourages his clients in or near retirement to consider a higher equity allocation. To do so, he uses this real-life example.
“A former colleague’s wife was a teacher,” he says. “While she was working, salaries were frozen, yet the retirees had a fully inflation indexed pension. So people who’d been retired for 15 years were now making more from their pensions than people who were working.”
That story usually shocks clients into realizing the effects of inflation.
Most of McKenzie’s clients then ask if their bond allocations should match their ages (the traditional standard). He steers them away from this approach, and encourages them to remain at a 60% equities, 40% fixed-income split, even into retirement.
“You still need to have money growing in order to keep up with your lifestyle, especially when you start tacking on 2% or 3% to the required return every year [to account for inflation],” he says.
“Also, if you’re invested in bonds you’re going to lose half in tax.”
To increase clients’ comfort level with that allocation, McKenzie demonstrates how the liquid portions of their portfolios can sustain them.
“If markets are going down, you still have 40% of your portfolio to draw from in the meantime. When markets rise, you can sell high. [That helps them] buy into the fact that they need to have money growing, not sitting still.”
As clients pass 65, their portfolios stay close to 60/40. McKenzie only ratchets down equities if someone needs more cash flow. And if a client wants her investments to fund an inheritance, McKenzie may recommend an equity allocation that’s higher than 60% since the time horizon is longer.
Even if clients see the logic behind higher equity allocations, they may not be able to stomach market swings.
Michael Jones, founder and CIO of RiverFront Investment Group in Richmond, Va, puts it this way: Stocks are well priced right now, in some cases a bargain, so history would suggest they’re almost certain to make money over the next five years. “But they’re going to put you through hell.”
This is a good entry point, he adds, because stocks are “about 20% below the long term trend” and because “historically, during periods which begin with [valuations that are] 20% below the long-term trend, investors have made money relative to inflation.”
This has happened 95% of the time during the five years following a large value drop—even in the Great Depression. Stocks are only inexpensive because there’s something to be worried about. “Every period that’s been this cheap was also extremely volatile.”
To keep clients on an even keel, Clark relates required returns to goals, not market events. “If a client has $1 million and needs [annual income of] $50,000, that’s a 5% return,” he says.
“I’ll say, ‘If you want to go into a Government of Canada bond, that’s 2%, and below what you need.’ Relate the portfolio construction to the growth and objectives of the client.”
McKenzie also brings the discussion back to fundamentals, asking clients, “Do you believe Coca-Cola or Shell will stick around? You’re buying a little piece of those companies. [What happens] this year or next doesn’t really mean much for what they will do over the next ten years.”
Read the full story: Push clients toward equities >