In one of the most memorable movie scenes of all time Butch Cassidy and the Sundance Kid find themselves trapped on top of a very high cliff overlooking a raging river. With the posse closing in, their only possible escape is to jump off the cliff into the river. The Kid is visibly reluctant and when Butch asks him what his problem is, the Kid replies “I don’t know how to swim!”...Butch starts to laugh uproariously and exclaims “Kid, it’s the fall that’s gonna kill ya!”
Sometimes our immediate fears cause us to overlook the larger risk and that is the case for many with respect to the recent turmoil in the financial markets. While the losses are of concern, the larger risk can be in how long it takes to recover. So, in this case it’s not the fall but the length of time it stays down that is the larger risk.
This “Recovery Risk” is highly sensitive to just how close an investor is to retirement.
Retired: Significant to Catastrophic Risk – for those drawing income the depletion of their capital is critical and a lengthy recovery seriously increases the chance they will run out of money. The risk is highest in the early retirement years and decreases somewhat for older retirees – a function of the total income needed for the balance of their lifetimes.
Within 15 Years of Retirement: Significant Risk – for those counting on investment growth for future retirement income, a lengthy recovery may result in a later retirement than planned and/or continued work of some sort during retirement. Those closer to retirement are at greater risk as they will start to draw income sooner.
More than 15 Years from Retirement: Possible Risk – historically, most recoveries take less than 15 years so the younger an investor is the lower the risk. Those in their 20’s and 30’s benefit from a long term investment period while the risk increases progressively starting at age 40.
For some perspective let’s take a look at the Dow Jones Industrial Average:
First, note that the Great Depression starting in 1929 saw the Dow fall by more than 85%, a magnitude of loss not seen since. But it’s the fact that the Dow did not recover for 25 years that was the bigger issue.
As you can see on the chart there have been other lengthy recovery periods including the one we are presently in, which began in October 1999.
So, what are the alternatives? Putting money into a Money Market Fund, Savings Account or GIC just locks in the loss of purchasing power over time:
Investment Amount $100,000
Interest Earned 4.0% $4,000
Income Tax 33.0% -$1,320
Inflation (July 2008) 3.4% -$3,400
Net Earnings -0.7% -$720
This may be viable for some retirees but is questionable for those under age 75.
Real Estate is another possibility although after 13 consecutive years of rising values we may be looking at a downturn soon. Prices in the GTA rose by less than 1% in the past year and sales are down more than 22%. It took more than 12 years for the real estate market to recover after the peak in 1989.
For those who have retired there is a way to guarantee retirement income of 5% for life while remaining invested such that future market gains may be realized. In fact, it is possible to have both the initial guarantee and to improve upon the guarantee value through resets over time.
For those within 15 years of retirement there is a way to guarantee 5% annual increases in future retirement income while remaining invested such that future market gains may be realized. In fact, it is possible to have both the initial guarantee and to improve upon the guarantee value through resets over time.
The Income Plus program was introduced in Canada less than 2 years ago and in my opinion is the best way in which to minimize risk for those who are building or drawing retirement income.
If you, or someone you know, is within 15 years of retirement or, has been retired for 15 years or less, you should learn more about Income Plus. In this period of uncertainty, it offers both a guaranteed minimum amount of income and the potential to benefit from future market gains – a unique combination in my experience and one which may not be available with the same features in the future.
In my view this is the best protection available today with respect to many risks but especially for Recovery Risk.
*Income Plus offers a unique benefit for new clients:
For those not taking an income in 2008, a 5% income bonus is paid on the initial deposit. This means that if you open an account before the end of the year you will receive a 5% increase in your Guaranteed Withdrawal Balance even though you may only have been a client for a few weeks or months.
New clients over age 65 may take a 5% income withdrawal in 2008 without reducing the amount of their guaranteed annual income for life.
In order to realize these benefits I recommend you act quickly as it often takes several weeks or longer to transfer funds and this benefit only applies to those funds received prior to December 31st.