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Monthly Retirement Tips

 

 

Febraury 2008

 

6 Strategies to Help Your Retirement Funds
(and your psyche) Weather a Market Dip

 These days, most people have been invested long enough to have experienced both a market downturn and the subsequent period of recovery.  If you are in this camp, you have probably also experienced the giddy exuberance that comes with exceptional gains, and then the fearful despair of pullbacks.  Ups and downs are the normal patterns.  Don't be blinded by either one.

Review the plan

Just knowing that there is a plan can go a long way to putting your mind at ease during a worrisome phase of normal market fluctuations. So, let's review.  What are the strategies in place to weather the periods of underperformance? A portfolio which is appropriately diversified amongst the asset classes will provide some opportunity to be selective when determining the source of your current draws. Is there a proportion of your portfolio in money market funds or other near-cash accounts from which to draw the income you require in the near term?  We call this the Cash Wedge.  It provides a stable source of short-term income so that you can minimize the need to 'Sell Low.' Is the Asset Allocation still appropriate for your Risk Profile?  Remember the risk/reward trade-off.  During periods of market outperformance, investors tend to be overconfident.  They also suffer from "return-envy" -- i.e. they are susceptible to the selective boasting of friends and fund companies who may be exaggerating their total experience by emphasizing the positive and forgetting to mention the negative.  As a result, investors may become dissatisfied and want to chase returns. The occasional home run may give you a moment of elation, but the volatility associated with that investment may have a downside drop that is gut-wrenching.  In our experience, there are many 'plodders' who won't give you the extreme ups and downs but will land you in the same, if not better, spot over the long term.  What's most important to you? What is your personal strategy to reconcile all the trade-offs? Are you a 'turtle' or a 'hare?'  Remember who won that race?

Review your withdrawal rate

Can you adjust your withdrawal rate? Maybe you can afford to draw just a little less now until the markets perk up again and your draws are being made into a rising market.  On a relative basis, are your current draws reasonable?  If your planned withdrawal was 6% of the value of your portfolio and your portfolio has dropped by 15%, your current draw may be closer to 7%.  Is this sustainable?  It may be, over the long run.  There will be  periods of outperformance, too, when your draw may be less than 6% on a relative basis.  But if you just want to ease your mind about drawing down too fast in a falling market, reduce your draw and cut back on your spending (if necessary) in the short run. 

Revisit the balance of draws against registered and non-registered savings  

If you have accumulated both registered (e.g. RRSP's, Locked-in Retirement Accounts transferred in from pension plans) and non-registered savings, you may be able to relieve the wear on your assets by changing the source of your income withdrawals. All withdrawals from 'registered' accounts are 100% taxable at your highest marginal tax rate.  For example, if your total income is between $30,000 and $65,000, your 'marginal tax rate' may be about 35% on each new dollar of income you claim between those levels.  To get a dollar to spend from 'registered' savings, then, you will need to draw out approx. $1.54 and pay tax of 54 cents.  If, however, you want to create a dollar of spendable income from your non-registered savings, it is an 'icing and cake' situation.  The original principal of those savings has already had the tax paid on it, so it would not be taxable again.  This is the cake.  Depending on how your savings have been invested and for how long, only the accumulated growth that has not already been taxed will be subject to taxation on withdrawal.  This is the icing.  The icing is taxable, the cake is not. Usually, the growth is in the form of 'capital gains' which themselves are only subject to tax on one half of the total gain.  So, hypothetically, to get one dollar of after-tax income (net) from non-registered savings might mean that you only need to draw (e.g.) $1.05 (gross) from your savings.  When compared to drawing from registered savings, this could substantially reduce the short-term stress on your savings. 

Review your tax planning strategies

A market downturn might be a good opportunity to 'crystallize' capital losses in non-registered savings accounts that could be applied against future or past capital gains.  If you have paid tax on capital gains in previous years, you may be able to recover some of that tax.  Less tax means more money to spend. As of 2007, Pension Splitting was introduced to help lower the tax bill for couples.  This may apply in your situation so make sure you investigate the possibility.  It may be another way to reduce tax and create more spendable income. 

Consider swapping  interest income for dividend income

Dividend income from large-company, blue-chip stocks is not guaranteed, but can be reasonably expected to be stable and predictable.  Furthermore, it is more tax-effective than interest income and may have a nominal yield that is equal to, or better, than current interest rates.  And if that isn't enough, you have excellent potential for actually growing your capital via the growth in the price of the underlying stocks.  Swapping interest income (100% taxable) for dividend income (tax-favoured) in non-registered accounts is a prudent strategy for even the most conservative investor.  (If you are over 65, check with your advisor to see how dividend income might impact clawbacks and assessments in your circumstances.)

Don't lose perspective

In most cases, today's bottom line isn't relevant in the long term.  Unless you need to use all of your assets today, the current market value is only one pricepoint in a very long trendline.  If you are drawing income, you are only drawing one bucket a month from the well.  The majority of your portfolio will have time to wait out the market cycle and be in a position to benefit from the period of renewed growth that always follows a pullback.  Do review your current plan to remind yourself of the strategies in place to deal with the issues that cause you the greatest amount of stress, but don't rush to make wholesale changes.  You probably only need to make some minor adjustments, if any.   It's a good time to meet with your advisor if you haven't already done so. 
Monthly Retirement Tips Archives
February 2008 Monthly Retirement Tip PDF
January 2008 Monthly Retirement Tip PDF
October 2007 Monthly Retirement Tip PDF