Conventional wisdom says bonds are safe; equities are risky.
We don't live in conventional times.
Clients have earned virtually nothing during the past three to four years on their cash and short-term bond investments, notes Michael Jones, founder and CIO of RiverFront Investment Group in Richmond, Va. in a talk at the Investment Management Consultants Association's conference in National Harbor, Md.
To add insult to injury, prices have gone up 14%-to-15% in the same period. "A big chunk of their portfolios aren't keeping pace with the rising cost of living," he says.
Yet, clients continue to buy fixed-income because coupon payments are comforting and predictable. And those same investors continue to "redeem out of equity in droves," says Jones, because they're scared of stocks after 2008's crash.
As a result, boomers in particular put their retirement income at risk of "death by a thousand cuts."
Joel Clark, managing partner at KJ Harrison in Toronto, says boomers face a tripartite threat.
"Interest rates are low, the stock market is volatile, and inflation is strong," he says.
"So 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. 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?
The first thing to explain: "There is no risk-free asset," says Jones.
Phaby Utomo, executive director and senior private wealth manager at UBS Wealth Management in Toronto, agrees.
"Traditionally, people think of sovereign debt as being risk-free," she says.
"But even certain countries have defaulted; Argentina did it in 2011. Recently, investors in Greek government bonds got back around 30% of their original investments."
So, Scott McKenzie, regional vice-president and general manager at T.E.
Wealth in Toronto, encourages his clients (primarily those 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.