When markets are volatile, it's normal to feel anxiety or the need to do something. First and foremost, it's crucial to take care of your physical health. But you might be asking yourself, "Is my financial strategy still OK?" Although we can't predict when the volatility will end, the following guidance can help you navigate the current uncertainty and help ensure your retirement savings can provide for your needs throughout your life.
You may be more prepared than you think
Whether or not you feel emotionally prepared, you and your Edward Jones advisor may have already prepared financially for today's environment. While we can't predict market declines, we know they're normal, so we incorporate several considerations into your financial strategy to help you be prepared.
Your strategy is based on your goals and comfort with risk
When we develop a financial strategy, it begins with what you are trying to accomplish. We consider your goals, income needs and comfort with risk to tailor a strategy specific to you. This includes selecting a portfolio objective and an asset allocation (your mix of stocks and bonds) based on the expected return and expected risk we believe are necessary to reach your goals.
Importantly, having balance between stocks and bonds can better equip you to navigate a down market and ensure a decline doesn't completely derail your strategy, while providing for your needs over time. As highlighted below, a balanced portfolio has historically been able to hold up better during down markets while providing competitive returns over time.
A balanced allocation can help reduce the impact of declines
Source: Morningstar. Through 3/31/20. Balanced Growth & Income Portfolio is composed of: 4% cash; 38% Investment-grade bonds; 4% high-yield bonds; 4% international bonds; 17% Canadian large cap stocks; 3% real estate, 11% U.S. large cap stocks. 7% developed overseas large-cap stocks; 3% U.S. small- and mid-cap Stocks; 1% developed overseas small- and mid-cap stocks; 3% emerging markets stocks.
This graph compares the average annual return of the S&P/TSX Composite index against that of a balanced growth and income portfolio (see Source below the graph for the portfolio's composition) during two recent down markets. In 2020 (through March 31, 2020) the balanced portfolio had an annual return of -6.90% while the S&P/TSX Composite index stood at -20.90%. In 2008, the balanced portfolio had an annual return of -10.92% while the S&P/TSX Composite index stood at -33.00%. Taking all the average annual returns into account for the past 15 years, the balanced portfolio had a 6.01% annual return outperforming the S&P/TSX Composite index 5.19% return.
Actions to consider:
Review your goals: Before we can determine if any adjustments need to be made, we first need to confirm that your goals and comfort with risk are still accurate, and therefore your portfolio objective is still appropriate.
And pause before making major changes: But before you make any changes, ask the following: Has anything changed with what you are trying to accomplish, or has your comfort with risk changed? Importantly, risk and return go hand in hand – it is possible you have been taking more risk than you were comfortable with, but we also need to ensure you are taking the appropriate amount of risk to achieve your goals.
At the same time, don't automatically make changes just because a downturn has occurred. While what we may be going through with the pandemic may be unprecedented, market declines are actually quite normal. In fact, we experience about a 20% decline in the markets every four years – meaning you could experience five to 10 of these over your retirement (source: Bloomberg). Your financial advisor can review your goals and comfort with risk to ensure your portfolio objective still is appropriate to accomplish your long-term goals, as well as provide for your needs over the near term.
Your portfolio is designed with a purpose
Investments don't all behave the same way at the same time. And, importantly, each investment within your portfolio serves a valuable purpose, helping to provide for your income needs today as well as over the long term.
As part of our diversification guidance, we recommend that you have about a year's worth of income needs from your portfolio in cash, as well as another three to five years' worth of income needs from your portfolio in GICs and short-term fixed income.
Actions to consider:
Spend from your cash: During a downturn, your emotions may tell you to make changes and potentially sell stocks, but stocks are there to provide for your long-term income many years in the future, as shown in the graphic above. Your near-term income needs are already addressed by your cash and short-term fixed income in your portfolio (as well as other sources, such as CPP or OAS, dividends and interest, and maybe even a pension), so you can withdraw from them, allowing your stocks to recover over time.
And rebalance if appropriate: After ensuring you have enough cash to provide for your near-term needs as well as in your emergency fund, don't feel the need to carry too much cash. Now may be the time to rebalance your portfolio, using this as an opportunity to add more to your stocks when they are down in value. How much you add to rebalance should be based on your portfolio objective, mentioned in the first section. Importantly, if you don't have enough cash on hand, now is the time to look at your budget and your outside sources of income and see if you can adjust your spending and build your cash reserve over time.
You have a spending strategy, built to last
How much you withdraw from your portfolio each year is perhaps the most important item in ensuring your money lasts as long as you need it. This is why we recommend starting with a more conservative withdrawal rate – for example, about 4% annually for someone in his or her mid-60s. As we show in the graphic below, starting with this withdrawal rate gives your portfolio about a 90% probability of lasting over a 25-year period.
So even though our expectations for a balanced portfolio may average 4.5%-6.5% annually over time, we recommend a more conservative withdrawal strategy because investment performance is not smooth – some years it's higher, some years lower. We also want to build in some cushion for inflation – or the general rise in prices over time. This doesn't mean you won't still need to be flexible — a 90% probability is not a guarantee. But if you start conservative with your withdrawals, any adjustments you need to make along the way may be more modest.
Actions to consider
Review your withdrawal rate and consider making adjustments: Even if you are still withdrawing at a conservative rate, there are things you can do to better position your portfolio (and spending) for long-term success. For example, suppose you just retired, and we end up having a year like 2008 where your portfolio could have fallen 20% in value. If you made no changes, the 4% you were going to withdraw is now actually 5% because your portfolio is down 20%. Should you consider any changes? The short answer is: It depends.
This recent decline has happened quickly, and if we see the economy and the markets rebound in the near term, fewer adjustments may need to be made. That said, what if you made some adjustments during declines, such as not increasing your withdrawals, or making modest adjustments to your spending?
In fact, you may have already adjusted your spending based on the stay-at-home measures – for example, spending less on travel and entertainment. As highlighted below, your spending behaviour can have a major effect on your portfolio's long-term success.
Review your reliance rate: Your reliance rate tells you how much you are relying on your portfolio – as opposed to other income sources, such as CPP or OAS – for your income needs. For example, if you need $60,000 in income each year, and $40,000 is coming from your portfolio, your reliance rate is 66%.
Notably, the higher your reliance rate is, the more sensitive you, and your strategy, could be to fluctuations in your portfolio's value, particularly if you have a lower risk tolerance or less flexibility with your expenses. In this case, you might consider other solutions, such as annuities, which could not only provide lifetime payments you cannot outlive, but also reduce your reliance rate.
Your behaviour can drive your success
Source: Morningstar, Edward Jones estimates. Probability of Success is over a 25-year period
This graph offers four scenarios to show that how much you withdraw from your portfolio each year is perhaps the most important item in ensuring your money lasts as long as you need it. In the first example, you have a 90% probability of your $1 million retirement portfolio lasting over a 25-year period if you withdraw 4% annually. In the second example, you have a 55% probability of your $1 million retirement portfolio lasting over same period of time if you withdraw 5% annually and don't make any spending adjustments. In the third example, you have a 70% probability of your $1 million retirement portfolio lasting over a 25-year period if you withdraw 5% and don't give yourself raises in years when your portfolio declines. In the final example, you have a 90% probability of your $1 million retirement portfolio lasting over a 25-year period if you take start with an initial annual 5% withdraw rate but take a 10% spending cut at some point and don't give yourself raises in years when your portfolio declines.
Putting yourself in control
While we cannot control the markets or the current environment, there are some items we can control. Just as we can do things to help control the spread of the virus and protect our physical health, we can control certain factors to maintain our financial health, including:
- Your goals and risk tolerance
- Your portfolio diversification
- Your spending strategy
Even more important, you control something much more significant for your long-term success – your emotions. So before you consider making changes, talk to your Edward Jones financial advisor Together you can review where you are today, whether you're still on track to reach your goals, or if any adjustments need to be made.
Ultimately, you'll experience many ups and downs over the course of your retirement. The key is starting with a solid foundation using the elements outlined above, and making adjustments when necessary to navigate declines as they occur. This will help you ensure your retirement strategy is built to last, providing for your needs throughout your retirement.
Unless otherwise noted, the above withdrawal rates assume an annual increase in withdrawals of 3% per year for inflation and can include the withdrawal of principal. If preserving principal is a high priority and/or you have little flexibility to adjust your withdrawals during weak periods for the markets, you may need to use a lower withdrawal rate. In general, the higher your withdrawal rate, the greater the risk that your money may not last throughout your time horizon. Withdrawal rates are based on estimates and assume a Balanced Growth & Income portfolio.