In a perfect world clients would see their returns skyrocket without putting their capital at risk. But life’s not perfect.
Protecting capital while maintaining and growing investor returns is a challenge all advisors face, especially as the client is entering retirement. Clients want more money in their accounts but that’s difficult to do without taking on risk. While advisors can invest in low yielding fixed-income products, they may have to get creative if they want better returns and safeguard capital too.
David Stewart, principal at Toronto-based Stewart & Kett Financial Advisors, believes a balanced mandate is the best way to achieve growth and protection. “That tries to give you the best of both worlds,” he says.
Creating a portfolio with an even mix of equities and bonds may not be as exciting as an all-stock basket, but if maintaining capital is the goal, clients will have to settle.
“People have to understand their dynamic and learn to live with it,” he says. “A balanced portfolio is designed to satisfy both objectives.”
While a balanced fund provides some room to grow and mitigates risk, there are guaranteed minimum withdrawal benefit products (GMWB) and seg funds, which John Sabourin, a CFP and founder of London, Ont.-based Selectpath sometimes uses. A GMWB will protect the initial investment, but there is a big downside: high fees that will eat into your client’s return. Still, Sabourin says it helps clients stay on track when times get tough.
He’s also keen on traditional annuities, but admits rates are low. “Annuities are a valid choice, especially for people in their 70s,” says Sabourin. “There’s a mortality gain built into the pricing — if you live a long life your rate of return gets better.”
A general rule for retirees is to own dividend paying stocks and while that won’t protect a client’s principal, it will provide income they can use for their day-to-day living and hopefully make investors feel safe in market downturns.
“Dividend investing works well if you have an educated investor who understands that if you bought a company and it goes down that you don’t sell it, as long as the dividend is secure,” says Nancy Woods, an investment advisor at RBC. In fact, that’s usually the time to buy some more.
No matter what strategy you use, it’s wise to match assets to the importance of the liabilities they are funding. The more important the goal – such as a secure retirement, or funding a child’s education – the less risk there should be in the account.
“Give a portfolio structure,” says Stewart. “If people need capital in the short-term, be it several years worth of cash flow demand that has to be safe, put it in a money market or short-term bond so they know they’ve got some money preserved.
“They can say ‘I have my longer-term money that I need in 15 years, but because I have a short-term reserve I don’t have to panic in market volatility’,” he adds.
None of these options may satisfy investors who want big returns. So, perhaps the most important thing an advisor can do when facing such a demand is to manage client expectations.
If someone came to Woods and said they want to make money but protect principal, she would be honest. “There’s no such thing as a real 100% safe investment — maybe Government of Canada bonds, but if you look at Greece is there really even that?” she says. “I don’t want to be misguiding people into thinking that there is a magic solution out there. If there was, we’d all be doing it.”
Stewart, agrees that the best policy is being direct with the client. “How are you going to get growth without some compromise on risk?” he asks. “Clients have to learn to accept that one involves the other, but a lot of people have unrealistic expectations that they will get some above average growth without losing some money.”
Boomers in particular have a hard time coming to grips with the fact that they may not see their retirement savings grow as much as they’d like. “They have a bit more of an ‘I want it all’ attitude,” says Sabourin. “It puts more of a challenge on sustainability of retirement income.”
“A lot of it is just looking at reality,” says Stewart. “I don’t want people to be too timid in their portfolio — don’t just sit in cash that erodes away — but clients have to evaluate their faith in the market. They also have to face up to what they’ve got, and deal with it.”