Saving for retirement: Company pensions

I'm not a financial advisor. I'm simply a retired photographer. Yet, I've done well in retirement. My portfolio is much larger today than it was when I retired. And I've pulled off this magic trick despite having to withdraw money annually to live in retirement. How has this been possible? Luck!

I retired in early 2009 in the middle of the one of the worst market crashes in history. I put every penny into the market. It was the best move I've have ever made. The luck was not in investing. That is rarely a bad move, especially if you have a long time horizon. No, the luck was having the market at an historic low. One cannot plan for events like that but only take advantage of them if given a chance.

My financial luck has burnished my reputation as a knowledgeable investor. I do my best but take my thoughts with a grain of salt, as they say. I'm a retired photographer, not a financial advisor, and never forget it. 

Now, to get down to the reason for this post: to give a well-loved grand niece some financial advice on how best to save for retirement. Because this post is directed to one person, some of the stuff touched upon will be very specific.

First: my niece has a company pension. What kind of plan is it? She must find out. Is it a DB (defined benefit) plan or a DC (defined contribution) plan? The Government of Canada has a page examining both approaches. Here is a link: Employer pension plans.

The important thing to remember is that a defined benefit pension is predictable. It is not directly subject to stock market volatility. When the pension begins, monthly payment is pre-determined. On the other hand, a defined contribution pension has contributions that go into mutual funds. Those mutual funds are subject to stock and bond market fluctuations, the investments will rise and fall in value. The pension’s eventual payments will depend on how the investments performed over the years. Read this article in MoneySense: Understanding your company pension plan.

My gut feeling is my niece has a defined contribution plan to which the company matches my niece's contributions up to a maximum of 1% of her gross income but with one caveat; the company's contribution is not to exceed $1000 annually. The 1% contribution is the minimum allowed by law.

In most cases like this, the employee should take full advantage of the company's matching contribution offer. To do less is leaving money on the table, as they say. Take all the company money and double your retirement savings instantly, but that's not all one can do.

Most defined contribution plans are a mix of mutual funds: Canadian, U.S. equity funds plus international equity funds and bond funds. Ideally, the mix of mutual funds will match your investment risk profile. Often plan members are encouraged to select a mix of investments that match their investment temperament and goals. 

My wife, a very bold lady, was a member of a DC plan. She picked the mutual fund mix that offered the greatest growth at the most risk. This meant it was equity heavy and bond deficient. One must make sure that the investment mix accurately reflects their stomach for risk. 

Investments go up and investment go down. Bonds tend to even out the ride. Bold investors choose an 80 (equity) and 20 (bond) mix. More conservative investors like a 60:40 split. Me? I have no bonds. None. But I may be going to 90:10 mix in the future.

There is a maximum amount a person can tuck away in an RRSP. If, after contributing to the company plan, one has more money to invest, money over and above that matched by company, many believe it is will do best put into a bank-offered RRSP. Why? The management expense ratio (MER) or investment management fees (IMF) should be much, much lower.

Most company pension plans are run by large financial institutions occasionally charging as much as 3% for the institution's expertise. That's a lot. I believe my relative may be paying around 2.75% in management fees. I'd wager she almost certainly is paying more than 1.5%. She should look into this. If her management fees are at 1% or below, she can leave her plan untouched and just modify the bond component to get better growth (with more risk.). Compare this to a complete portfolio in one ETF like XGRO. It has a MER charge of only .2%.

I like XGRO but there is also a similar asset allocation ETF from Vanguard, VGRO, and one from the Bank of Montreal, ZGRO. If the growth aspect frightens you. There are other portfolio mixes. Some are more balanced, others try to be even more conservative and still others are weighted toward dividends.

The problem with ETFs is that one needs a self-directed plan to buy these. The ET stands for exchange traded. Furthermore, unless one has a minimum of $15,000 to $25,000, depending on the bank, there is a quarterly plan charge. This fee reduces the advantage of low management fees. Many ETFs today can be purchased trading fee free.

Mutual funds, on the other hand, can simply be purchased at the bank. On the downside, the MERs are higher than those for ETFs. My advice? Put retirement money in mutual funds held inside an RRSP until one has enough to open a self-directed investment account large enough to escape paying the quarterly charges. Fees are portfolio growth killers.

I don't know of any complete portfolios in one mutual fund but since there is no fee for buying many mutual funds building a complete portfolio is not all that difficult. Here is my attempt. I have created a demo portfolio and will begin tracking it as of last Friday. The MER charges with this mix is in the .85 range.

My withdrawal method: an answer inspired by Wayne

 

I've been posting and tweeting about my approach to managing my savings in retirement. I've been hoping a curious financial pages reporter would contact me and take an in-depth look at my approach. No interest. I've also hoped someone might read my tweets and posts and help me polish my approach. Here, I have had some luck.

 

Wayne asks an excellent question which recalls an issue raised by Frederick Vettese in Retirement Income for Life. As we age, many of us will lose mental acumen - the ability to make good judgments and quick, well-thought out decisions.

His answer? An annuity at age 75 or 80. But Vettese warns, do not put the purchase off too long. To learn more, read his book. It is a good read.

Now, to answer Wayne's question. A self-directed investment account is not as difficult to direct as one might think. But, he's right to worry. I'm going to act on his question and have a serious talk with both my youngest daughter and my wife. I think my daughter could manage my self-directed account if I were unable and I know my wife could but won't. (And as I write this response, I am beginning to appreciate how very right Wayne was.)

The rest of this post is what I will have to address in the meeting with daughter and wife: 

I use TD WebBroker but there are lots of choices. I'll tell them to spend some time looking around if they don't like WebBroker. They might find something they like better. They can take their time. They can google it.

Originally, my portfolio was my own design. Today, it is almost a mirror image of the Morningstar Canadian Income Portfolio. Morningstar updates its recommendations monthly. TD, BMO and others carry the Morningstar suggested portfolio report.

If Morningstar were to halt its monthly updates, then a dividend weighted ETF would be a good alternative. I'd buy a Canadian one, an American one and one ex-North America one. Vanguard, iShares and some Canadian banks offer suitable ETFs. Again, I'd sayGoogle it. And I'd check out the Canadian Couch Potato.

TD will post the mandatory SD RIF withdrawal early every January. This is the amount I transfer in-kind, as equities and not cash, to my TFSA. If there is not enough contribution room in the TFSA, the remaining balance is transferred, again in-kind, to my non-registered account.

TD also posts the Projected Income for each SD account. This is the amount to be withdrawn in cash annually to live. With any luck, this should be more than four percent of the SD account. I always withhold 30 percent for possible income tax charges. Why so much. Because the mandatory withdrawal does not have income tax withheld. This charge comes due in the following hear. The 30 percent withholding cushions future financial shocks. I transfer the dividend income from my RIF to my bank account annually in early January. (Note: the Projected Income is the income expected to be realized in the coming year. It is a future looking number. But, if there have not been a lot of changes in the portfolio, I find the amount shown works just fine. I usually have the cash available.)

I find I must call TD and deal with a WebBroker rep. directly in order to make the equity transfers from my RIF to my TFSA. My wife was at my side this year as I did this. I hope she learned a little.

When talking with the TD rep, I keep my computer handy and a spreadsheet on the screen. I tell the TD rep what equity I want to transfer, they tell me the value of the shares at the moment and I key this value into my spreadsheet. They tell me how many shares they are transferring and how much cash and my spreadsheet confirms their calculations. With both of us in agreement, the transfers are made. (If this blog ever takes off, I'll find a way of posting my spreadsheet for all to download.)

When it comes to the cash withdrawals, no assistance is needed. This can easily be done online. Making a cash withdrawal is very straight forward. Neither my daughter nor my wife would find this difficult.

 Here are instuctions in bullet form:

• Open an SD RIF account.
• Buy stock or ETFs. I follow the Morningstar Canadian Income Portfolio plan. Aim for an investment mix that yields more than four percent.
• In early January annually, find the posted mandatory SD RIF withdrawal.
• Find and/or calculate you TFSA contribution headroom. Go to My CRA for this information.
• Call TD WebBroker and transfer in-kind an amount equal to your RIF mandatory withdrawal or TFSA contribution headroom from your RIF to your TFSA. Use whichever amount is less. You do not want to over-contribute to your TFSA.
• Any remaining mandatory withdrawal balance is transferred in-kind to an SD Non-registered account.
• Finally withdraw an amount equal to the annual dividend income. If it is too much more than four percent, don't feel pressured to remove the maximum if it is not necessary. Transfer the cash from the RIF to a bank account. This can be done without assistance. The TD WebBroker site makes this very easy.

Please read this carefully. I am only a retired photojournalist trying to share my thoughts on living in retirement. This is how I am my retirement savings and it has worked for me for almost twelve full years. Will it continue to work? That is a good question and I am hoping others may find my posts interesting and comment. We all might learn something.

What will I do if the market drops?

What will I do if the market drops? Hold on for dear life. Look to my wife for strength. She has nerves of steel. Vanguard has an excellent site looking at this situation: Remember, this has happened before.

Vanguard agrees with me: ". . . do nothing. This may seem to fly in the face of reason . . . (but) this is great news for those of us who are saving for retirement . . . " Never ever forget that when the market drops stocks are on sale. Buy. You are getting a great deal.

Vanguard Retirement Nest Egg Calculator

Vanguard Retirement Nest Egg Calculator

The longer you can run your retirement portfolio successfully, the longer your money will last according to the Monte Carlo calculators I have consulted. This one, posted by Vanguard, indicates I am actually much better off today in my 70s than I was more than a decade ago in my early 60s. 

My portfolio is almost twice its size today as compared to its size at my retirement. And although I have more funds, these funds do not have to last anywhere near as long. As time passes, it looks more and more like my wife and I will make it through our retirement years without running out of money.

Take a look at the calculator and see what it tells you.

Why so much financial advice leaves me shaking my head.

 Read the following story. It was published as part of a Canadian bank's presentation explaining investing to newbies.

 

Meet Lisa… - she is 64 and wants to retire next year. She recently inherited 80 thousand dollars, She has average knowledge of investing and she also has 50 thousand dollars saved in her RSP Lisa runs through these questions before she sets out to create her portfolio… 

How much money does she need? And how often does she need it? After going through her budget, she estimates that she needs an extra 500 dollars a month on top of her pension. How long does she need this income? She thinks her lifestyle and budget won't change over the next ten years. How much does she have to invest right now? She will invest the inheritance of 80 thousand dollars, plus the 50 thousand dollars in her RSP. 

How much risk can she tolerate? Lisa needs this income because she is retired but she also wants to minimize losses to what she has now. Because of this her risk tolerance is low. What are the implications to her income taxes? Lisa is also in a low-income tax bracket. She decides that the amount of money she receives from her investments is more important than how the income is taxed. 

Since her risk tolerance is low, she rules out investing in stocks for dividends. She decides that she will focus on different bond and cash products instead. This income investment strategy may be ideal for Lisa . . . 

 

Did you read the bank-posted story and say, "Whoa!" This lady needs $500 a month or $6000 a year. She has some $130,000 in cash. She could divide her investment among six stocks and keep $10,000 in cash to get her past the rough spots. 

She could easily make 5.0% in dividends or $6000 in cash. This just gets her by. Bonds and GICs are clearly out. Stock ownership is the only way for Lisa to go. The bank must explain this to Lisa, hold her hand during the rough spots and nurse her along. An acceptance of low risk tolerance will not pay the bills.

BCE (Bell) yields 6.08% today.

ENB (Enbridge) yields 8.10% today.

CM (CIBC) yields 5.29% today.

EMA (Emera) yields 4.73% today.

T (Telus) yields 4.87% today.

ALA (AltaGas) 5.34% today.

The above portfolio should give Lisa 5.72% yield on her stock holdings or $6864 annual income or $572 per month. Her $10,000 can be put in a cash account yielding about .75% and her extra cash income from her dividends can be saved, as well. Her cash reserves will grow by about $939 or 9.4% on her $10,000 in cash savings. (Some of this will disappear to pay some income tax fees. The exact amount to be determined by Lisa's tax bracket.)

 

 

Withdrawal Strategies to Avoid

I posted a take on a Million Dollar Portfolio Demo I set up in response to a brochure from Fisher Investments Canada. You can read that post HERE. I based my piece on the approach I am using to withdraw funds from my own RRIF.  I had hoped to hear from Fisher but I didn't. 

Though I did find a semi-critique of my method in the book Retirement Income for Life by Frederick Vettese, the former chief actuary at Morneau Shepell. Vettese knows his stuff. In a chapter entitled Strategies to Avoid he discusses the Withdrawing Only the Interest strategy.

He writes that spending only the investment income might make some sense for the lucky retirees with six-figure investment income but that is not me. Still, it appears I am not alone in pursing this strategy. Vettese calls the approach "popular" and a crude form of risk management.

Vettese writes the withdrawing-only-the-interest strategy looks better in theory than it does in practice. He makes it very clear this strategy is not one of his preferred approaches. To read about these, buy his book. I did and I consider it money well spent.

That said, I'm sticking with my variation on the withdraw-only-the-interest approach. It has worked for me for more than a decade. Although I have to admit to being worried that one success is not an adquate test. Am I being fooled by randomness? I did retire in 2009, near the depths of an historic stock market retreat. One couldn't ask for a better time to be entering the market with oodles of fresh "buyout" cash.

So, how does my approach work exactly?

• At 71 you convert your RRSP to an RRIF.
• There is no minimum withdrawal in the first year. This mean any and all fund withdrawn in the first year are subject to withholding tax. 
  
• At 72 one withdraws the minimum amount in-kind by transferring equities from the RRIF to a TFSA. If there is not enough contribution headroom in the TFSA, the excess funds are deposited as in-kind transfers into a non registered account. There is no withholding tax on minimum withdrawals. But be aware that tax must be paid in the following year.
  
• Next, four percent of the RRIF value is withdrawn in cash. Knowing this cash would be needed, dividend income was allowed to collect in the RRIF. As my dividends at the moment yield more than four percent annually, there is always adequate cash in the RRIF for the withdrawals. These funds, which are over the minimum, are fully exposed to withholding tax. I have the maximum, 30 percent, withheld.
  
• The goal is to lower the value of the RRIF in anticipation of the approaching higher and higher withdrawal demands of the government. A side benefit is the rapid increase in the value of one's TFSA. All dividends removed from TFSAs are tax-free: a nice bonus. As dividend cash is removed, contribution room is created in the TFSA to be used in the following year. 

My big question is: Can this method, with all RRIF funds in equities except for the approximately 10 percent in cash, survive the ups and downs, especially the downs, corrections and bears, encountered by stock market investors? All I can say is that so far it has worked well for me for eleven years. 

I'm optimistic. Why? Check the chart below. Bulls tend to be stronger and longer lasting than bears. If one can ride out the bad times, I believe one can survive the downturns. This is one reason I have a maximum of ten percent or a little more in cash. That cash, plus my dividends, should protect my equity holdings from any forced liquidation. (I have my fingers crossed.)

What extremes has the TSX hit since the mid '50s?

I need an editor. My original post was riddled with math errors and bull/bear confusion. If you read this post and find an error, please comment. I don't mind criticism. Thank you.

The average bear market decline between1956 and October 31, 2008 was a drop of 28%. The worst decline was 46% between September 2000 and July 2002. It was a bear with a run of a month shy of two full years.

Two bear market tied for the weakest bear market position with falls of only 17%. One lasted only seven months and the other lasted eight. But, these two were not close to the shortest bear markets. That achievement belongs to a three month long bear market that ran from August to October of 1987. It was short but the decline hit 31%.

A bear market is inevitably followed by a bull market. The best bull (before our recent record run) ran for 48 months from December 1976 to November 1980 and reached a gain of 161%.  The November 1990 to April 1998 bull had a gain that was almost as good at 160% but it took 90 months to hit this peak. One can take comfort in the knowledge that the average bull market sports an impressive gain of 79%.

If you play with the numbers you will find that a few bad, deep bears interspersed with weak bulls could leave one with a severely weakened portfolio. The whole success of the portfolio would come down to the dividends. If a lot of the dividends got reduced, one could be in serious trouble. But, many of the stocks in my million dollar portfolio demo are famous for weathering bad bears without cutting the dividends.

The three longest bear markets in Canada lasted  23, 19 and 17 months. Not a one lasted even two full years! Bears tend to be on the short side. On the other hand, the longest bull markets in Canada went for 90, 64 and 48 months. The three shortest bull markets went on for 5, 16 and 18 and 18 and 18 months. Yes, there were three bulls of the same duration: 18 months. Timewise, bulls tend to outlast bears. Bulls historically have had more staying power.

I cannot tell the future. No one can. But, it is reasonable to believe that there is a fair chance a million dollar portfolio with a yield approaching five percent would last a person through their retirement, no matter how long they lived.

My Million Dollar Portfolio Demo has about $60,000 in cash. That cash is unaffected by bear declines. Only the equity portion of the portfolio suffers from the bear drop. The cash holds its value and even grows a little thanks to dividends.

That cash, when considered in tandem with the dividend income, should guarantee, well pretty much guarantee, that no equities would face fire-sale liquidations. That small amount of cash in a million dollar portfolio plays an important role that is all out of proportion to its small value.

Bull and Bear Markets in Canada since 1956