STAY­ING STEADY: IN­COME STRATE­GIES

Investment Executive - - BYB: RETIREMENT -

When de­vel­op­ing de­cu­mu­la­tion strate­gies for clients in their re­tire­ment years, many fi­nan­cial ad­vi­sors seek al­ter­na­tives to tra­di­tional port­fo­lios bal­anced be­tween equities and fixed-in­come.

In some cases, ad­vi­sors are for­go­ing bonds and sup­port­ing the de­sired life­style of in­creas­ingly long-liv­ing and ac­tive re­tired clients through a com­bi­na­tion of equities and cash “buck­ets.” Many ad­vi­sors also are us­ing more pack­aged in­come funds, which hold di­ver­si­fied, non-tra­di­tional in­come assets, in­clud­ing com­mon and pre­ferred shares, global bonds and real es­tate in­vest­ment trusts.

stocks and cash buck­ets For those us­ing the stock and cash bucket ap­proach, the lion’s share of a re­tire­ment port­fo­lio is al­lo­cated to equities to meet the need for growth and in­fla­tion pro­tec­tion in what could be a three-decade or longer re­tire­ment. The pur­pose of cash buck­ets is to meet fore­see­able spend­ing needs for two to five years at a time. As cash buck­ets are de­pleted, they’re re­plen­ished by sell­ing equities in­cre­men­tally — either on a reg­u­lar ba­sis, such as an­nu­ally, or at op­por­tune times, when val­u­a­tions are high. By hav­ing a liq­uid pool of assets at all times, re­tirees can main­tain their de­sired spend­ing level through the in­evitable stock mar­ket ups and downs, as well as ben­e­fit from the long-term growth in the share of the port­fo­lio that’s held in a di­ver­si­fied pool of equities.

Paul Delfino, direc­tor, wealth man­age­ment, and senior wealth ad­vi­sor at Sco­ti­aMcLeod, a di­vi­sion of Sco­tia Cap­i­tal Inc. in Kanata, Ont., spends a lot of time ed­u­cat­ing his clients about why stocks are nec­es­sary to fund a 30-year re­tire­ment. How­ever, he also warns clients that they must ex­pect con­tin­u­ing global con­flicts, changes in po­lit­i­cal lead­er­ship and var­i­ous other events that will trig­ger down­turns. He rec­om­mends a three-year cash bucket for re­tirees, view­ing it as a “fi­nan­cial bomb shel­ter” that will shel­ter clients against mar­ket crashes, al­le­vi­ate their fears and en­cour­age them to stick to the plan. Mean­while, Delfino’s clients will be able to main­tain or in­crease pur­chas­ing power by hav­ing a sig­nif­i­cant amount of assets in­vested longer-term in stocks to take ad­van­tage of growth in the good years. “Volatil­ity is not the risk. The risk is [clients] out­liv­ing their money or los­ing pur­chas­ing power,” Delfino says.

A typ­i­cal client with $1 mil­lion at the out­set could set aside enough in the cash bucket to pro­vide in­come of $5,000 a month or $60,000 per year, which adds up to $180,000 for three years or 18% of the orig­i­nal port­fo­lio, Delfino says. If mar­kets rise or are rel­a­tively sta­ble, he will sell enough stock to re­plen­ish the bucket ev­ery year. But, if mar­kets drop, the client has enough cash to last three years be­fore be­ing forced to sell any equities at re­duced prices.

De­lay­ing the re­plen­ish­ment of a cash bucket un­til equities re­cover can’t be done in­def­i­nitely and could re­sult in an in­come cut­back dur­ing a pro­longed stock slump. For clients with suf­fi­cient means, a more con­ser­va­tive ap­proach would be for the bucket to be ex­panded to hold five years worth of liv­ing ex­penses. The trick to this strat­egy is in re­fill­ing the cash bucket, and this can be done through both re­bal­anc­ing at reg­u­lar in­ter­vals, such as an­nu­ally or semi­an­nu­ally, and adding div­i­dends earned in the equities side of the port­fo­lio. If the equities are de­signed to pro­duce a div­i­dend in­come of 2%-3%, that can be fac­tored into the client’s an­nual in­come stream, so the size of the cash bucket can be re­duced ac­cord­ingly.

Delfino spends con­sid­er­able time con­duct­ing “lifeboat drills” with his clients. He re­views what might hap­pen to their as­set val­ues dur­ing a mar­ket crash and en­sures clients’ ex­pec­ta­tions are re­al­is­tic. Delfino’s re­search found there have been 13 se­vere mar­ket cor­rec­tions since the Sec­ond World War, with an av­er­age drop of 33% in the U.S.-based Stan­dard & Poor’s 500 com­pos­ite in­dex. The av­er­age time from peak to trough was 17 months.

“It’s bet­ter to go through the lifeboat drill be­fore you leave port than when after you’ve hit ice and are tak­ing on wa­ter in the north At­lantic,” Delfino says. “Sur­prise is the mother of panic. No panic, no sell; no sell, no loss. ”

bal­anced funds,growth and cash As well as cash buck­ets, many ad­vi­sors and their clients rely more on multi-as­set in­come funds or pack­aged fund-of-fund port­fo­lios that pay out a pre­de­ter­mined rate of an­nual in­come, of­ten on a con­ve­nient monthly ba­sis.

Typ­i­cally, th­ese port­fo­lios in­vest in in­come-pro­duc­ing assets, which may in­clude div­i­dend-pay­ing com­mon shares, pre­ferred shares, govern­ment bonds, cor­po­rate bonds or in­ter­na­tional bonds of var­i­ous types, in­clud­ing those is­sued in emerg­ing mar­kets. Fund port­fo­lio man­agers take care of promised in­come pay­ments and re­bal­anc­ing, thus spar­ing you and your client from mak­ing de­ci­sions on which se­cu­ri­ties to sell and when.

Daryl Di­a­mond, pres­i­dent of Di­a­mond Re­tire­ment Plan­ning Ltd. in Win­nipeg and au­thor of Your Re­tire­ment In­come Blue­print, typ­i­cally in­vests 80% of a re­tiree’s assets in bal­anced in­come funds that de­liver a pre­de­ter­mined monthly pay­out. He also puts 15% of assets in growth-ori­ented, eq­ui­ties­based mu­tual funds and 5% in cash. The growth bucket holds a mix of large-cap and high div­i­dend-pay­ing stocks, as well as some small-caps to add ex­tra long-term re­turn po­ten­tial.

Most of Di­a­mond’s clients have re­tire­ment port­fo­lios of $1 mil­lion-$2.5 mil­lion in assets. If the growth bucket in­creases in value be­yond the orig­i­nal al­lo­ca­tion pa­ram­e­ters, assets can be sold down and either added to the in­come­pro­duc­ing pot or used to top up the cash bucket, he says. The cash bucket is used as a “buf­fer” to sup­ple­ment in­come if nec­es­sary.

Dis­tri­bu­tions from the in­come funds typ­i­cally are 5% a year, but are not guar­an­teed, which is why Di­a­mond fo­cuses on a hand­ful of well-man­aged funds that have a record of re­li­ably pay­ing their dis­tri­bu­tions and also have achieved growth be­yond that.

“To have the cash flow man­aged by a com­pe­tent pro­fes­sional man­ager, in ad­di­tion to the as­set al­lo­ca­tion and se­lec­tion of se­cu­ri­ties, is very com­fort­able, ” Di­a­mond says. “Clients do not have to de­cide which in­vest­ments to sell or when.”

He teaches clients to view fi­nan­cial assets as akin to real es­tate prop­er­ties, from which they can take com­fort in spend­ing the rent with­out hav­ing to sell the prop­er­ties to cre­ate an in­come. And this, he says, has a pos­i­tive ef­fect on client be­hav­iour.

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