Living beyond your savings…


After a euphoric move to the upside that Donald Trump claims credit for, the market seems to have peaked in January and entered a corrective phase. Volatility in the markets is up but not beyond the norm if we take a longer perspective.  What is less “normal” is the fact the 2017 had no volatility.

We said last quarter that the stock market is not expensive relative to bonds. While this is still true, rising interest rates will be a major headwind to stocks over the coming months. Until companies can show that the corporate tax cut had a positive impact on the economy, and their bottom line, over the long term, markets will be in a pause mode. Interest rates (on a 10-year US treasury bond) having moved up to 2.8% have changed the PE (price/earnings) landscape: the bond market PE has moved from 50 to 33 times and the stock market is at 18-20 times after the correction.

Our view regarding “living on your savings” and financial planning

As many of our clients approach retirement, we have had many questions about financial planning, particularly as it relates to their pool of capital and how it will “weather the storm” for the years after they stop working. It is a reasonable worry: as Mrs. Alicia Munnell, director of the center for Retirement Research at Boston College, said back in 2012; “It's just not possible for [most] people to work for 30 or 40 years and support themselves on their assets for another 20 or 30 years, let alone the cases where retirement years exceed the number of years an individual spent in the workplace.

The quick glib answer is that if you keep your spending below your income, you will not spend your capital and you will not have an issue in retirement. I am sure this is obvious to all of you. However, how much can you spend and not outlive your capital?

We did a presentation back in 2014 entitled “Will History Repeat?” where we looked back all the way to 1914 and simulated several spending assumptions and their related impact on a portfolio every 30-year period since 1914 (that is 70 observations). Not to bore you with the details, here is what we found:

On a 1 million dollar portfolio with 50% Equity and 50% Fixed Income:

  1. If your total spending (including paying your taxes because taxes are a real spending in case you have any doubt) is $40,000 a year, indexed to inflation annually, your chance of outliving your pool of capital is less than 5% (this means you will die leaving an estate);
  2. If the amount of spending is above $40,000 and below $80,000, the odds of outliving your capital increases exponentially. However, it is still below 50%;
  3. If the amount of spending is above $80,000, it is a certainty that your pool of capital will decline over time but we are not sure when it will hit 0. Hopefully, just as the cheque for your funeral hits your bank account, and bounces!

We then simulated different asset allocation assumptions in order to see their related impact on the initial pool of capital and this is what we found:

  • Without an equity allocation (i.e. 100% Fixed Income), the odds of running out of capital within the 30-year period is more than 50% of the time;
  • 70-75% in an equity allocation seems to be the sweet spot;
  • Unless you are willing to drastically reduce your spending, the allocation to fixed income should not exceed 50% of your portfolio.

As to the need for financial planning, we would like to point out some of the myths you should know about:

  1. Most financial planners offer the service for free because they try to sell you a product (most often involving insurance because the commissions involved are the highest);
  2. Here are a couple of things we remember from school: There is no certainty in anything except death and taxes, and there is no such thing as a free lunch.  Most people probably do not need financial planning involving some expensive and semi sophisticated tax planning.  You need a good accountant and a knowledgeable investment advisor;
  3. Buying insurance to cover your bank loans after your death is similar to saying:  ‘I will overspend now and hopefully somebody else will pay my debts’;
  4. Using a straight line growth rate to do financial planning is nonsense because it is unrealistic.  Planning is more about probability.  By the way, it is very easy to make believe that a client has enough money just by increasing the rate of return assumptions.  By the time he finds out the reality, it will be too late to change the outcome. 

These are the approaches used by a lot of financial planners to sell products.

In conclusion, our advice is:

  • If need be, use financial planners who sell no products. We can certainly assist you in determining if you require a financial plan, so talk to us.  If we feel that you need a more sophisticated approach, we would refer you to a professional in the field, who will charge by the hour or by the report.
  • Tax laws change enough that buying insurance should not be part of planning, especially if it is to take advantage of some tax loopholes, which is how many insurance products are sold.
  • If you have “mortgaged” the legacy you planned to leave your family and loved ones (i.e. you still have debt when you retire but have no plan to pay it back), it is possible that your only option will be insurance, a very expensive alternative, which locks in total dollar outcome but not the cost if you live longer than you expect. You may buy a policy that you cannot afford to keep until you die, so the money you spent will be wasted. Insurance is intended for very specific purposes. By definition, it is to protect you from some unexpected, potentially disastrous, event. Using it as part of a growth strategy appears to be a contradiction. It should never be meant to fund your lifestyle spending.

Managing your withdrawals from your accounts under our care

Regarding withdrawals from your account, you should know that every time you withdraw funds from your investment accounts we need to sell some investments to rebalance the accounts.  The bigger the amounts the more time and longer the rebalancing takes.  Consequently, if you are planning a large withdrawal, you should let us know in advance (preferably 3 to 6 months instead of 3 to 6 days).

Your investment account should not be considered a bank account because market performance is unpredictable in the short term (up to 2 to 3 years), you may end up selling and withdrawing your funds at the bottom of a correction.

What we do in investments is by nature long term (i.e. 5 years and up).  Theoretically, if you need some funds within that time frame, you should let us know so we can plan accordingly (stay in short term investments for the amount of money you will need).

Your withdrawal of funds from your investment accounts, if excessive (for example, it exceeds the income being generated by a significant amount), will hinder the growth rate of your capital and reduce future income, thereby worsening eventual outcomes.

The Claret Team