Most people probably don’t think about retirement when they are working and busy with life. And then one day there is a trigger. Some life event, like a spouse who is nearing full pension eligibility, the last child leaves the family home, or a 30th work anniversary starts the process of considering retirement.
Popular media glorifies retirement with glossy pictures of healthy retirees on a beach living the golden years. That is part of it, but retirement is just another stage of life with both new adventures and new challenges. There are five critical areas to plan for as you think about retirement:
1) Maintaining social connections
2) Staying healthy and active
3) Planning fun things (this is where the beach comes in!)
4) Intellectual pursuits
5) Your finances
Most people retire in their 60s and 70s and the approach is a large multi-step process that includes planning for retirement, transition to retirement and then finally being retired. This article is for those who are starting the journey and are considering impact on their finances and investments.
During your full-time career years your investment portfolio was a place to put money to work and grow. You didn’t care too much about volatility because bear markets were an opportunity to add at a lower cost and there was time for prices to recover. Monthly income was a by-product of your asset-allocation but not a real focus as everything was being re-invested anyway. As you near retirement, that changes.
For the first time you will want to know how much monthly income you can generate. For the early stage of retirement, it is highly recommended that you spend income, not capital. This gives you time to adjust into retirement financially and live within your new means. It also puts the focus on generating steady monthly income and not worrying about bull or bear markets. Now your goals will switch from growth to maximizing income, minimizing withdrawals and maintaining purchasing power. The good news is that there are many good income investments available, and below is a starter list for consideration with your advisor.
Investments grade bonds – we have had a significant increase in interest rates, and bonds are once again an investible option. Yields today are producing income that is at or slightly higher than inflation. ETFs are a great way to access this asset category with their low cost and transparency. The biggest factor in bond prices is the prevailing interest rate environment, and the longer the duration of the bond, the greater the impact. You can express a duration view easily with the various ETFs available.
High yield (junk) bonds – maximizing income generated in your portfolio is going to involve some higher risk taking. High yield bonds are issued by firms with lower credit ratings, so they offer higher returns. ETFs are still a great way to access this asset category with their low cost and transparency, but you might also consider an active manager who can steer around firms that might default. Default is the main risk with this asset category. One suggestion is to look to the US market as it is much larger and more diversified than the Canadian market.
Real estate – adding real estate to your income mix is a great diversifier as it’s a great inflation hedge. Recall, one of our goals is to maintain purchasing power. REITs are great options, either bought directly or through ETFs. Given the current housing shortage and moves to e-commerce, a focus on multi-family, industrial and data centers is the best bet. Once again, Canada offers some good options but for deeper diversification away from some of the weaker areas like retail and office space, you can look to the US markets.
Utilities – everybody needs them in good times or bad. Adding utilities to an income portfolio is yet another great diversification tactic to gain yields slightly higher than what you can get from investment grade bonds. Utilities are highly regulated and capital-intensive operations, so their upside is somewhat limited, and they are sensitive to interest rate moves. But the higher yields and inflation protection makes them worthy of consideration either through ETFs or direct investment.
Innovative active strategies – the good news is that we are all living longer, but that gives inflation more time to erode our purchasing power. Covered-call strategies, adding modest leverage and niche real estate options all are popular options that can add further yield, diversification and inflation protection. Given that many of these are new, a bit more complex and not as widely distributed it is best to work with your advisor.
The transition to retirement brings change and new stresses. For most of use that will mean replacing the social and intellectual elements of our full-time career and taking care of our health. With a bit of planning with your advisor, you can switch from a growth-oriented investment playbook to an income-oriented playbook easily. With that off the planning checklist you will have more time and energy for the bigger opportunities and challenges of retirement - like planning your beach vacation!
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