Readers often ask how an index investing approach can work for retirees or soon-to-be retirees. A low cost, globally diversified portfolio of ETFs is great for those in the accumulation stage, but retirees need income. How do they get it?
When asked this question I often point to this excellent piece in MoneySense written by Dan Bortolotti. It elegantly explains how to generate retirement income using a total return approach that allows you to maintain a portfolio of equity and bond ETFs.
Dan’s article does indeed show investors a better way to generate retirement income with ETFs. But the strategy can be complicated for a do-it-yourself investor to carry out in practice. Asset-allocation ETFs help simplify the process somewhat, but investors still need to manage multiple accounts, deal with mandatory RRIF withdrawals, and try to keep taxes to a minimum.
A Robo-Advisor Retirement Solution
Enter the robo-advisor. Once thought of as just an investment platform for Millennials, robo-advisors are well-positioned to take on the retirement income challenge. In fact, one of the fastest growing segments at Wealthsimple are retirees and those nearing retirement.
I spoke with Michael Allen, a Portfolio Manager at Wealthsimple, to get a real-life example of someone using a robo-advisor in retirement to manage their investments and withdrawals.
To start, Wealthsimple sets up the client with a globally diversified indexed portfolio that’s well-suited to their lifestyle needs and risk tolerance.
“Many people have the misconception that being in retirement means they need to change their strategy to focus on income producing assets. We don’t think this is true,” says Allen.
What matters is the total return of the portfolio relative to its risk. By relaxing the focus on yield, and using broad market index funds instead, a portfolio can be diversified across all sectors of the market instead of concentrating in companies that typically pay high dividends (e.g. financials, utilities, and consumer staples). This added diversification reduces risk without sacrificing expected return.
What’s more, increased tax efficiency is also a product of a total-return approach since capital gains — which are taxed at a lower rate than dividends or interest — account for more of the expected return over time.
With a total return approach, it is usually necessary to sell holdings periodically in order to generate funds for spending needs. In past times, when it was common to pay significant commissions to trade, this was a problem and a focus on income may have been warranted. Today, however, commissions are minimal for trades, including Wealthsimple where they are typically zero.
“Rather than pay out income, we automate monthly withdrawals. Each month we will sell units of funds to raise the required income need,” says Allen.
This is a form of rebalancing, as holdings that have drifted above their target weight are trimmed before assets that are under their weight. In a scenario where stocks were down significantly, income would be raised by selling bonds.
Let’s look at a hypothetical example of how this works with a holistic retirement strategy.
Wealthsimple Case Study: Retirement Withdrawals
Allison and Ted were long time clients of one of the bank owned brokerages. Both are 65 and recently retired. They were paying high fees for one phone call each year with their advisor.
They came to Wealthsimple for lower fees. But they also wanted high-quality advice from advisors with a fiduciary responsibility to look out for their best interests. And, the assurance of a consistent investment strategy over the coming decades. That way, if Ted had to one day assume the role of managing the household finances, a responsibility he doesn’t currently own, the transition would be less stressful.
Allison and Ted transferred TFSAs, RRIFs, and Joint accounts to Wealthsimple. Their goal is to fund retirement and leave an estate to their children. Spending needs are $80,000 per year. Their total portfolio is worth $1,700,000.
Understanding their existing accounts, annual spending needs and long term goals, the team at Wealthsimple was able to propose a retirement investment strategy curated specifically for them.
First, Wealthsimple created a financial plan to determine their ability to achieve their desired level of spending until age 95 and developed a tax efficient strategy for pulling funds from their various accounts.
A balanced and globally diversified portfolio was recommended, with 50% equity and 50% fixed income. Broad-based, low-cost ETFs were used to form the portfolio and fund selection was tailored to account type to minimize taxation.
It was also recommended that they defer CPP until 70 and begin drawing down on the RRIFs instead. Pulling on the registered funds earlier than necessary minimizes the risk of higher taxes in the future and potential OAS clawbacks as well.
“We suggested withdrawing $70,000 a year. Combined with Old Age Security benefits and modest withdrawals this satisfied their lifestyle needs and kept all income in the lowest tax bracket,” says Allen.
To produce consistent income, an automated monthly withdrawal of about $5,800 was set up from their RRIFs. Allison and Ted don’t have to worry about what to sell, as a rules-based rebalancing methodology automatically sold funds that were over-weight to generate funds for withdrawals. As a result, their portfolio consistently remained close to its target weight.
At the present time, Allison and Ted are projected to meet their spending needs, adjusted for inflation, and leave an estate of around $500,000 in today’s dollars for their beneficiaries.
Each year the plan is updated to incorporate any changes in Allison and Ted’s circumstances as goals, as well as how markets have performed relative to expectations. And at any point over the course of their retirement, Ted and Allison have access to our team of advisors should they have any thoughts, questions, or concerns about their portfolio and investment strategy.
Retirees don’t need to chase high yield investments, or substitute dividend stocks for bonds, in order to build a sustainable retirement income stream. You can meet your spending needs using a total return approach with equity and bond ETFs (along with a cash / GIC bucket for short-term spending).
And while asset allocation ETFs have lessened the burden on investors who manage their own portfolio, a robo-advisor solution like the one outlined above can manage your retirement income withdrawals in a simple and tax-efficient manner.
Did you know Boomer & Echo readers get their first $10,000 managed free for one year when they open up a new Wealthsimple account? Transfer your account to Wealthsimple and they will cover the transfer fee.
Readers: Who’s interested in using a robo-advisor in retirement? You can book an appointment to speak with a Wealthsimple portfolio manager today about your personal retirement scenario.