Retirement Mistake No.17: Not Diversifying Investments
Posted In: Retirement Planning for Entrepreneurs

Joe Millionaire’s Retirement Income Plan

Joe from Nanoose Bay dropped by to update me on his retirement income plan and to let me know he’s on track. He has a retirement income plan that is suitable for a 65-year-old senior with a conservative investment focus.

Joe splits his investments up five ways.

How He Does It

  • Firstly, 20% is invested into one- and five-year GICs. Called a “barbell” approach, this invests half into short-term investments. The other half is poured into long-term investments, taking advantage of averaging interest rates.
  • The next 40% is then invested into fixed income. This consists of a portfolio of bonds and bond funds including Government bonds, real-return bonds, high-yield bonds, and preferred shares. Joe likes the consistency of his fixed income portfolio and safety of GICs, since he had about 60% overall invested into conservative and less choppy (volatile) investments.
  • Thirdly, the next 20% is in income trust funds, which invest into income-generating investments to give a monthly income. These consist of oil and gas, resource trusts, real estate, and business trusts. Joe likes the fact that the income is less taxing than interest income and that the strong oil and gas price and rise in real estate helps offset inflation.
  • The final 20% produces income by being invested into dividend income pooled funds, stock funds that invest in companies that pay strong dividends. The dividend payout also gives Joe additional monthly income.

Each section of his portfolio will pay out income on a monthly or quarterly basis.

Joe wants to retain most of his capital and occasionally dips into principal to go on his expensive holidays. In the next five years, Joe wants to decrease the 40% equity to 20% and hopefully spend more on his travels. He is comfortable with the diversification into five asset areas. That way he can see from where his income will be generated, the specific dollar amounts of  cash flow coming in, and what he can typically expect from each asset class. Now Joe can spend more time planning his next big trip accordingly.

Building an Income Portfolio 

“How can you generate sufficient income to match my income needs and risk tolerance?”

This question was from Bob from Nanoose Bay.

Bob’s Situation

His situation is similar to that of many retirees faced with income needs at a time when stock markets remain uncertain and interest rates are low. Bob needs about $550 per month or 6.6% to supplement his income. He has $100,000 to invest. Unfortunately, we can’t get him 6.6% in a term deposit. So we discussed looking for the highest-yielding term deposits, which are around 4.7% (rates subject to change)–well short of his required 6.6%.

Then we discussed other options such as corporate bonds, Government bonds, income trusts, dividend funds, and balanced funds. While he wants the income, Bob really wants an income portfolio. Based on his conservative risk tolerance he doesn’t mind taking some risk.

Solution

We then looked at some model income portfolios and their risks and came up with some possible portfolio options. Each portfolio is different in the amount of risk and in the amount of tax he will pay (interest, dividend income, or capital gains income).

Here are some examples of simple mutual fund structures he can develop for his income portfolio:

  • 50% Federal and Provincial bonds and 50% corporate bonds.
  • 50% term deposits and 50% corporate bonds.
  • 33% preferred equities, 33% income trusts, and 33% dividend-paying common equities.
  • 25% corporate bonds, 25% preferred equities, 25% income trusts, and 25% dividend paying common equities.

The income trusts used in these examples consist of a fund that invests in 25% business trusts, 25% real estate investment trusts, 25% resource trusts, and 25% utility trusts.

Now Bob understands. By combining lower-risk income options with potentially higher-return income options, he can generate income for his retirement that can match his risk tolerance and monthly cash flow.  In addition, he can look at existing portfolios that can generate income and preserve capital for investors. As a result, he will see that over his time horizon, he can achieve his financial goals.

Get excited and enthusiastic about your own dream. This excitement is like a  forest fire–you can smell it, taste it, and see it from a mile away.- Denis Waitley

You can do anything if  you have enthusiasm. Enthusiasm is the yeast that makes  your hopes rise to the stars. With it, there is accomplishment. Without it there are only alibis. – Henry Ford

 

Published with permission from Grant Hicks