BY FAZAAD BACCHUS
It is important to have an average return on a portfolio over a period of time but equally or more important is to pay careful attention to the timeliness of these returns.
Let us examine the case of Marsha and her husband James: (real names withheld).
Both started saving for their retirement in the late 90’s and by the time they were ready to retire they had amassed a very reasonable amount of money together. This money will provide for them during their retirement years and they were satisfied. However, it was observed that James’ monies didn’t quite grow as much as Marsha’s did. When they inquired of their advisor about it they were told that James had as much a return as his wife did and they were shown statements to support the return credited over the period.
Further analysis into their portfolio revealed that even though the average returns were the same, James had very bad early years. The losses he suffered in those early years were significant enough that he couldn’t recover fully. It is difficult to predict market volatility and unfortunately James faced it. Take for example a loss in one year of 10% of your portfolio means that the market needs to perform at 11% the following year for you to recover. But what if the market falls and your investment falls as much as 50%? Well, what would it take to recover, a whopping 100% just to break even. Therefore, it’s important when investing that you understand how these market falls can affect your money.
James and Marsha are now ready for retirement and this period could be for another 20 to 25 years. It’s important that they don’t run out money. An acceptable problem is one where your money outlives you but not where you outlive your money, this is the stage where handouts and charity become necessary. This duo is not prepared to make the same mistake but how can they avoid it. One option is to put their money in GIC or bonds but with interest rates being so low, it’s difficult to preserve their capital having to take draw downs on it.
They must continue to invest or reduce their standard of living. The second is not really an option also as they would like to enjoy their golden years. Therefore, James and Marsha have to assess the risk associated with high returns and the effects in can have on their portfolio. Should either of them experience early losses in their retirement years it could eat up quite a significant portion of their capital. This would present a calamity as they are also no longer contributing to their RRSP.
This situation is a common one here in Canada and retirees need to manage their risk and return properly. It would be a dangerous venture to try to get hefty returns from a portfolio only to suffer early losses, unrecoverable. My advice for this couple after I took over the management of their portfolio was to move into safer funds with less volatility and still have an acceptable level of return. I am of the firm opinion that it is “Better a return of principal than a return on principal.”