Retirees may be forced to keep risking investments

The turmoil in Greece, hot on the heels of the financial crisis and the tech wreck before, may have future retirees scurrying to the safety of fixed income again but investors should keep their focus squarely on growth to avoid outliving their portfolios, a new report argues.

"Retirees should keep a significant portion of their wealth allocated to risky assets, like stocks, in order to provide enough growth over the long run and avoid prematurely depleting their wealth," Kurt E. Reiman, a strategist at UBS AG said in a note to clients.

At retirement, investors have typically been taught to become more risk averse by reducing their exposure to equities and other growth assets in favour of fixed-income securities such as bonds. Indeed, a well-worn rule of thumb is to allocate your age in bonds. In other words, at 70 years of age, an investor should hold 70% bonds, and 30% equities.

But traditional cookie-cutter retirement approaches that recommend reduced risk for all may not do the trick anymore.

"I use it as starting point, but many portfolios need more growth in order for people to retire on their own terms these days," Adrian Mastracci, a portfolio manager at KCM Wealth Management Inc. in Vancouver, said.

According to Mr. Reiman, a variety of societal trends has rendered retirement as we know it a thing of the past. As a result, that is creating new financial objectives for investors that are much more personalized in nature compared with the largely shared retirement mindset of the past.

"Pension plans, both public and private, face imminent funding pressure because there are fewer people working and more people retiring," he said.

"Medical costs and spending on health care services are on the rise as well, which burdens government finances even further. At the same time, people are anticipating longer active lives, with some form of employment potentially a part of the picture."

Mr. Reiman said these trends are not happening in isolation, but instead are converging to alter how people perceive their relationship to their career and how they plan to pay for the time when their careers end.

Faced with growing pressures to meet their spending needs, wants and wishes, retirees are also dealing with increasing levels of uncertainty and complexity related to financial risks, such as market volatility and inflation.

To combat these challenges, he said more portfolio growth is needed. He recommended a portfolio that includes stocks, commodities or real estate, highlighting two strategies that offer growth, but also provide a degree of safety for investors.

The first is a laddered approach of short-term bonds maturing over the next five years, and an additional growth portfolio for the longer run. "The main advantage of this strategy is that investors can weather storms on the financial markets, he said.

"The retiree has a period of up to five years before he/she has to sell assets from the diversified growth portfolio. Therefore, the investor is not forced to sell assets in a severe bear market, but can hold onto his/her investments until the market has recovered."

A second approach is to consider annuities as part of the solution, which can better address longevity risk.

Mr. Mastracci said most of his clients in retirement fluctuate between 40% and 50% growth exposure in their portfolios in order to meet their individual needs. However, like the UBS report, he stressed the importance of ensuring each portfolio provides some degree of emotional comfort.

"Some people may need some extra juice in their portfolio, but they have to be satisfied with the potential extra risk," he said.

Financial Post

Markets have been bountiful, but there's risk in overstaying your welcome

How to take a profit

Markets have been bountiful, but there's risk in overstaying your welcome

David Pett, Financial Post

Illustration by Juan Carlos Solon/Financial Post

Buy low. It's the first step of the most famous investing cliche out there, and thanks to dirt-cheap prices in the wake of the financial crisis, it's never been easier to accomplish over the past year.

But with stock markets up more than 60% and hitting new recovery highs, now comes the tough part: selling high.

"An investor's biggest problem generally -- fund managers, retail investors, everyone -- is that they don't sell very well," said Joanne Hruska, a vice-president at Aston Hill Financial. "And there is nothing more frustrating than riding a stock up and riding it back down."

Deciding if, when and how to take profits is never clear-cut, and the dizzying rally that doesn't want to quit has left many investors unprepared to think about locking in gains. But smart investors who have a plan in place over what to do with their stocks tend to get burned far less often than those who don't.

George Athanassakos, a professor of finance at the Richard Ivey of School of Business, says investors should have an exit strategy even before buying a stock.

"More than that they need to be disciplined, consistent and patient," he said.

As a value investor, Mr. Athanassakos buys stocks that are trading at a discount of at least one-third intrinsic value. Generally, he likes to hold a stock for three to five years or longer, but when it hits full value, he exits.

Not without exception, of course. If a stock rises quickly in a very short period of time, the finance professor said it makes sense to get out even if it hasn't reached intrinsic value.

"If your target upside is 50% and the stock rises 30% in a week, get out and invest your money somewhere else that now offers better upside," he said.

That doesn't necessarily mean selling the whole position, but at a minimum Mr. Athanassakos said it is important to bring exposure back within preset positional limits. For diversification purposes, the typical weight of any one stock ranges from 3% or 5% of a total portfolio.

Additionally, he said it is prudent to lock in profits early when the business model of the company changes in a way you don't like.

He recalled the story of Shermag Inc., a Quebec-based furniture maker that earlier this decade stopped manufacturing its own product locally and decided to manufacture and distribute furniture made in China.

"Investors realized the stock was no longer the stock they bought and sold out in 2002 and 2003," he said. Sure enough, in 2008, Shermag filed for bankruptcy.

Robert Floyd, the lead manager at R.A. Floyd Capital Management Inc., admits to taking some knocks over his 30-year career because he didn't sell soon enough or didn't sell at all.

For him, knowing the right time to take profits is a matter of consistently reassessing the true worth of the underlying investment, whether it be a stock, bond, exchange-traded fund or commodity. At the same time, it is equally important knowing what to do with the proceeds of the sale.

"If you like a sector but the stock you own now trades at a premium value, look for another stock in the group that trades at a discount," Mr. Floyd said.

"In many respects, that is where we are in this market. There are some names that have gone wildly positive and others that are laggards that make more sense."

The other possibility, he said, is shifting out of the sector entirely into a cheaper sector that is trading at more attractive valuations.

As a total-return investor who views performance as a combination of capital gains and dividends, Mr. Floyd said people must never forget why they bought the stock in the first place. During the market collapse of 2008 and early 2009, he held on to Baytex Energy Trust, even though it got crushed.

"I didn't sell, because I thought it was a terrific cash machine. They did cut their distribution and it went from the mid-$30s to the teens, but I needed to generate income for my clients and it was still providing cash flow on a regular basis."

Valuing the worth of a stock to determine whether it trades at a discount or premium can be a complicated affair. It will depend largely on the company and sector being bought and sold, but also on the type of investment style being employed.

Managers who rely on fundamental analysis may look at earnings and revenue momentum as well as balance sheet strength, for instance, while technical analysts will rely on moving averages, resistance levels and seasonal indicators (Sell in May and Go Away).

Ms. Hruska, who runs an oil and gas fund, uses a combination of strategies, including cash flow multiples.

For example, she likes to buy companies that are trading at 3x cash flow, compared with 5x, which is the average for the group. Once it gets over 7x, she will consider selling it, but it is not always a hard and fast rule.

"We look at what the market is doing as well," she said. "If we see strength, we may extend for a few days. At the same time, we don't delay too long."

Colin Cieszynski, a market analyst at CMC Markets Canada, believes using fixed targets such as those utilized by Ms. Hruska makes for smart investing.

One method used by many of the short-term traders he advises is to sell once a stock either rises to a pre-determined price or falls to a pre-determined price.

"Generally, you would look for a stock where your return-to-risk ratio is at least two-to-one. In other words, a stock bought for $10 would be sold at $12 or more, or if it falls to $9.

"It is important to avoid marginal trades. If a stock could go up one dollar but down two, you don't want to make those trades."

Another method is to use a trailing stop. Using this strategy, investors stay invested as long as the trend is in their favour, Mr. Cieszynski said.

"You might start with a stop loss at 10% below the buy price. If the price goes up, you would keep moving the stop loss up in proportion. Therefore, you only sell when the stop loss is triggered," he said.

If the underlying stock is volatile, Mr. Cieszynski thinks a wider berth with your stop loss may be necessary so the trade does not get knocked out too early.

"If you are day trading, you probably go with some pretty tight stops. If it is weeks or months, there's probably more leeway," he added.

No matter what strategy one utilizes, Mr. Cieszynski cautions investors against becoming complacent.

"The market is dynamic and always changing, he said. "Be proactive, particularly in a consolidating market like we have today. You do not want to outstay your welcome."