I’m in my early seventies, a disciplined saver and cautious spender. My husband and I have built a substantial nest egg, helped along by an inheritance. I opened a portfolio of 50 per cent each in stocks and bonds in 2021. Then came 2022 and, unfortunately, I sold. Everything is now in cash and GICs, safe and unproductive. Work income will cover our expenses for the next two years, but then we’ll rely on investment income. I’m thinking of a combination of 65 per cent defensive, dividend-oriented, low volatility investments, and the rest in something “stable” as a buffer. But I don’t understand bonds, and after 2022, I don’t trust them. I want a plan that lets me sleep at night.
I don’t think the best solution is an easily prescribed portfolio. You’ve already found the financial equivalent of Tylenol in your GICs. They may ease the pain, but they’re not going to cure the underlying condition.
Sara McCullough, an advice-only planner at WD Development in Kitchener, Ont., said you face a common problem.
“When you have a cautious spender, these very ironic things happen. They’re the ones that end up with the money because they don’t spend it ... [but] it’s really difficult for them to see ups and downs.”
This is particularly true when bonds are involved. Many people think bonds are the safe, reliable part of their portfolio – and they can be. If you buy a bond and hold it to maturity, you know exactly how much money to expect: Regular, fixed-coupon payments plus the face value at maturity.
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Ms. McCullough said clients “get really offended” by declines in bonds – much more so than in stocks, which we accept will be volatile.
“If a toddler throws a tantrum, we’re not really surprised, right? It’s a toddler,” she said. “When bonds go down it’s like your grandmother throwing a tantrum.”
But companies and governments can default on their payments, and even if they don’t, bonds are tradable instruments with prices that rise and fall. If you’re holding a bond to maturity, a jump in inflation will take a bite out of that predictable income. With higher interest rates, investors will value newly issued, higher-paying bonds over older ones that pay less. Bond funds will slump as those prices drop.
That’s what happened to you. In an annual review, CIBC Private Wealth said 2022 had “one of the biggest, and the fastest rate hike cycle in the past 40 years,” which led to one of the worst years for Canadian bonds on record. Your timing, I’m afraid, could hardly have been worse.
Now, 2022 was an outlier. The same CIBC review said that a simultaneous annual drop in both stocks and bonds happens only 2 per cent of the time. But it could happen again, and even seemingly safe investments carry some degree of risk. Pointing to your plan for defensive, dividend-oriented, low-volatility stocks, Ms. McCullough noted that bank shares dropped sharply in 2008 along with the rest of the market. Being defensive doesn’t eliminate volatility.
Your choice of a nominally conservative 50/50 portfolio suggests you were rationally aware of the risks, but you may not have understood how paper losses would really feel. The inheritance makes things even harder.
Ms. McCullough said most people don’t approach inheritance money the same way as money earned. One client managed her own $2-million portfolio aggressively until she received a $200,000 inheritance.
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“It was paralyzing for her. She panicked. She could not make decisions.”
If you can’t cope with the stress of market gyrations you could always stay in cash and GICs, but, as you know, that means slow, steady losses to inflation and taxes. That will put you in a tricky spot in a few years when you plan to rely on investment income, Ms. McCullough said.
To preserve your spending power, she said, you need to take on risk. You need someone to walk you through what that risk looks like on its worst day and understand how that makes you feel. You need to internalize why it’s worth holding an investment even when it’s misbehaving and why market drops can be an opportunity.
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If I had to suggest a specific fix, you could keep a cushion in GICs and invest the rest in a broad asset-allocation exchange-traded fund. Keep it simple to avoid the temptation to tweak it, and build it based on a clear-eyed, non-judgmental understanding of what you can reliably hold yourself to.
But I’ve mentioned before that a good planner – ideally advice-only, to keep incentives aligned with yours – is as much a therapist as an investment adviser. If you want to sleep better at night, I would start there.
E-mail your questions to agalbraith@globeandmail.com. I’m not able to respond personally to e-mails but I choose certain questions to answer in my column.