Monthly Newsletter – November 2014

Hello Everyone:

More on Understanding Volatility:  In the previous two newsletters, we were trying to put volatility into meaningful parameters so that investors would not be ‘spooked’ by relatively benign market moves.  We discussed that markets are too often viewed as either ‘soaring’ or ‘crashing’ rather than seeing volatility as a normal corrective phase to bring overly exuberant pricing back to reality.  It makes good assets cheaper!

We also described Sam Stovall’s analysis on the duration of market corrections, i.e. that a 5% correction was just temporary noise and that corrections of 5-20% normally only lasted 2-4 months.  Even major bear market corrections usually last just18 months.  While the latter can be a pretty harrowing experience, the fact is that if you are well diversified into high quality assets with a significant holding in bonds to mitigate volatility and to rebalance your portfolio, you should emerge from the seeming abyss well positioned to take advantage of the next bull market. Certainly that has been my experience over the last 35 years in the industry whether through major events such as the financial crisis in 2008 or the Crash of ‘87 or the myriad of other events; recessions / tech bubble / two Iraq wars / 9/11 / Russian bond defaults / Ukraine / U.S. debt / Greece defaults , etc. The lesson is that properly structured portfolios will flourish provided that investors and their advisors don’t panic in the face of volatility. The S&P 500 is now up 150% since the crisis in 2008.

How Much Can I safely Withdraw From my Portfolio in Retirement?  Hopefully at this point we have alleviated some fears about volatility, but it still remains critical to our calculation of what we need to retire on. Financial Planners like to say that you need 70% of your preretirement income to avoid eating cat food and wearing worn socks! Nonsense! It may be partially true if your income was $50,000/year and you have low CPP contributions, but if you made $150,000, you don’t need $105,000 plus CPP and OAS to survive. The argument sure sells a lot of mutual funds though.

Withdrawal Rate: The normal estimate of a ‘withdrawal rate’ is about 4% annually.  I recently came across an excellent article by Peter Vettese, an actuary who writes frequently on investing in Moneysense, the Post, etc.  I am going to quote from his article extensively because he is asking the same question that you are. “Can my retirement funds withstand the stress test of a 4.5% withdrawal rate.”  Vettese suggests comparing how your investments would have done since 1960 if the asset allocation was similar to a pension fund, i.e. 60/40.

“Only once were fund returns negative two years in a row (1973-74).

The worst cumulative loss over any two years was -14.5% (2007-8).

The worst cumulative 3 year loss was just -4% (2006-8).

In any given decade, we can expect one or two years of net losses.

Every decade has included at least two and as many as seven years of returns over 10%.

The average annual return after fees was 8%.”

As you know, our portfolios are generally structured with the same asset allocation as a pension fund, about 5% cash, 35% fixed income and 60% equities. Because of meager fixed income returns, I substitute about 10% of the equities with covered calls to increase income.  In other words, a conservative growth portfolio targeting a return of 6-7% net of fees.  

For conservative modeling purposes, Vettese assumes lower returns of 5.5% over the next 25 years.  This spread between pension fund returns of 8% and RRIF returns of 5.5% could reflect the higher cost of mutual funds, which Vettese might be assuming most investors are using. Nonetheless, let’s use the more conservative return expectations into our estimates for the cash portfolio.  His sample $325,000 RRIF withdraws about 5% or $15000/year beginning at age 70, but still retains $75,000 at age 95.  Based on this example, Vettese reasons that ‘if one can achieve an average return of 5.5, it would take some rather extraordinary short term losses before the 4.5% spend rate became a problem.’  

While it is impossible to guesstimate future returns especially over 25 years, hopefully this discussion will mitigate some of your concerns about volatility.

Oils: The sudden decline in global oil prices has sent oil producers scrambling to reduce costs, and governments, including our own, to reshuffle budgets which derive much of their tax revenue from the energy sector. We shoukld remember however that the contribution of the energy sector,including coal,hydro and nuclear as well as gas and oil, is about 7% with fossil fuels about half of that. There are three plausible explanations for thisdecline in price. Firstly, that the development of fracking in the U.S. has brought much more oil to world markets than anticipated.  Secondly, that the Saudis and OPEC, by not reducing supply last week, want to squeeze higher cost producers, e.g. Canada/U.S./Nigeria, etc. out of the market and regain the control they had in previous decades. Thirdly, and this arouses my political suspicions, that the U.S. wants to weaken Putin and the Saudis  to skewer Iran.  In any event, I don’t believe that this will be long lasting but it is too early to tell. In non-registered accounts I have been taking a tax loss when necesary on XEG and replacing it with ZEO which contains pipelines and LNG as well as oil.

Thank you for your business.

John

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