Some people are very risk averse and investing does involve taking some risks. The fact that they are calculated risks, for which it is reasonable to expect a long-term profit separates investing vs gambling. However, there is a spectrum of risk, and it cannot be zero. There are also significant risks to your future if you choose the route of not investing. There is no risk-free option. Further, delaying your start to investing only compounds the risks. Learn about those risks to choose the most suitable path to invest for your future security.
Save money for the near-term, but don’t erode it long-term.
Saving money guarantees it is there to spend. Inflation guarantees it buys less.
Save the money that you need in the next 3-5 years. Do not invest it. Saving means that the money is guaranteed to be there when you need it. There are many ways to save money for the near term, but they will all likely return less than inflation. Particularly, once taxes are accounted for. That means the erosion of your buying power over time. So, saving for the long term is guaranteed to lose purchasing power. Still, it is vital to have enough savings to cover short-term needs rather than sell investments at a bad time because you need the money. You must have this stable platform built to then invest.
Invest for the Long-Term.
Invest to out-pace inflation in the long run.
Investments carry some risks and their prices fluctuate over time. Good investments are expected to return more than inflation over decades. More aggressive investments have higher long-term potential returns. You can see that born out in the chart below. Over 90 years, higher-risk investment types outpaced lower-risk ones. They all outpaced inflation.
Adjust how aggressively you invest to your time frame.
Over long time periods, equities (stocks) have grown ~4-5%/yr above the rate of inflation. That means not just preserving buying power, but actually increasing buying power. That is the long-term expectation, but there have been plenty of ups and downs over shorter time frames. Most of us are not investing for 90 years. Fortunately, even when a broad basket of higher-risk assets has a major down draft, they eventually recover within 5-10 years.
This is why investors diversify using multiple stocks mixed in with some less correlated lower volatility bonds. That asset allocation can change how deep and long drawdowns are. The shorter the time before you need the money, the more conservatively you should invest. Combining that with how much flexibility you have to change or delay your cash flow requirement is part of assessing your risk capacity.
Invest to insure against forced retirement.
Retirement planning is one of the main reasons why people save and invest. When retirement looms, having some savings to cover a few years’ expenses without selling more volatile investments is vital. Some will build a five-year GIC ladder to plan for that. Others will increase their percentage bond allocation. If you know exactly when you are going to retire, you can make these adjustments. Unfortunately, it is very common for things to not go as planned.
Plan for an unplanned early retirement.
A 2015 Angus Reid Survey showed that 48% of people were forced to retire before they had planned. That was most commonly due to personal health, family health, or job loss/modification. Physicians and other professionals are not immune to any of these realities. Even while self-employed in healthcare, the demands of practice can change with technology or other disruptors to the practice environment.
These issues are also not reserved for those in the twilight of their careers either. About 2/3 of unplanned early retirement occurs before age 60.
Investing mitigates the risk of Fancy Feast. Maybe a truncated career too.
The risk of a forced retirement is important to recognize. Particularly, for those whose risk aversion tempts them to forgo investing. It is possible that a high-income professional with moderate spending, and moderate goals could achieve those goals without investing. However, that would require a full career to go exactly as planned. If they are forced to retire early, then they may need to acquire a taste for feline cuisine. This is modeled in two scenarios below with a generous GIC return above inflation (haven’t seen that in a long time).
The other way that investing helps to mitigate the risk of truncating or stunting your career is by mitigating burn-out. If you have more financial independence by mid-career, then you have more options to affect the changes needed to pursue opportunities and change the parts that grind you down. With your money working for you, you can spend more time maintaining your human capital, extending your productive years.
Invest to get more after-tax money.
In the above scenarios, there were two features that made GICs better than what you could likely expect in real life. First, using an inflation-adjusted GIC return of 1%/yr was generous compared to historical real returns. The second reason is that I ignored taxes on interest and dividends. Income taxes would dramatically blunt the return for GICs. For example, if you are in the top personal tax bracket, over half the interest would be lost to taxes. You can only spend money after you have paid the taxes owed.
In contrast, most investment income is more lightly taxed. This is by deliberate design. Investment returns are taxed favorably because investing in equity carries more risk. A higher expected return is required to entice investors. Without investing to risk capital in new innovations, our economy would stagnate. So, favorable taxation to encourage investing benefits all of us living in a prosperous economy. Plus, the government revenues skimmed off that growth pay for social programs while also hopefully providing jobs that reduce the social support liabilities.
When a company that you invest in makes a profit, then either it pays some out as a dividend, re-invests to grow the company, or buys-back stock. Dividends from Canadian companies are taxed lightly in personal hands because the company has already paid corporate tax. Foreign dividends are taxed as income and sometimes some extra foreign taxes. Fortunately, the return on most investments is a small portion as a dividend and the rest as a capital gain from growing the company’s value. Capital gains are not taxed until you sell – they can continue to compound. Plus, they are taxed at half the usual rate when you do realize them to access the money.
Invest to protect against longevity risk.
Not only does investing put you on a stronger footing to handle life or career changes in late mid-age. Investing protects you against running out of money if you live longer than expected. Important, if your taste buds are as well-preserved as the rest of you. The threat of running out of money before your last breath is called longevity risk.
A mix of factors determines the risk of outliving your portfolio. It is easy to understand that the longer you live and the smaller your portfolio is at the time of retirement, the higher your longevity risk is. Hence, investing to accumulate more before you retire helps as already mentioned. However, luck and how you invest also play a role.
Sequence of Return Risk
If you are forced to withdraw money when your portfolio is down, it is unpleasant. That is inevitable because investments constantly fluctuate in price and you will need money to live on. However, if the drawdown happens around the start of retirement when your capital is at its peak, then there is less to take the ride back up. That is called sequence of returns risk (SORR) and it can shorten the lifespan of your portfolio.
Fortunately, there are multiple ways to mitigate that risk. As mentioned, you could build a five-year GIC ladder to draw from, instead of your investments, if you have an unlucky market crash in early retirement. Variable cashflow strategies, like working part-time into retirement or having some trimmable fat in the budget, also mitigate sequence risk. You could by products, like an annuity, or participate in a group defined-benefit pension plan. They can be expensive. So, you are exchanging some extra money for the guarantee and may need to make do with less for that. The sequence risk is increased by increased volatility. So, another approach is to adjust your investment portfolio.
Adapt your investments to reduce longevity risk. That means still investing.
If you don’t have the excess cash to build a GIC ladder or cash flow flexibility, then you might de-risk your portfolio as you approach retirement to reduce that volatility. That usually means adding bonds to dampen the portfolio price swings. If equity markets dump, bonds often rise, or at least dump less. So, you could preferentially sell bonds if the market laid an egg just when you needed some cash. This underlies the advice to progressively increase your bond allocation as you age. There are many variations.
However, that advice is most relevant for the window when the sequence risk is highest (usually 5 years on either side of retirement). The reality is that you still can’t ditch taking investment risks as you age. Once you are beyond the SORR window, then your main risk becomes not getting enough return above inflation again. That is particularly true if you retire at a young age and live to a ripe old one. Safe bonds have a low risk, but also a low expected return. Barely above inflation before taxes, perhaps trailing after tax. Ugh. So, you probably need to take some investment risk to safely outpace the inflation risk. That could even mean a rising equity glidepath for extremely long retirements.
Some will handle the shifting balance between SORR and longevity by shifting asset allocations at different stages of retirement. Those with a significant buffer from a lifetime of investing may be able to just stick to the asset allocation that matches their emotional risk tolerance assessment the whole time.
Prioritize & Act To Maximize Your Security
You must have a safe foundation before investing. That means debt at a level where you can absorb cash flow shocks and sleep at night. Enough money is securely saved to provide for your basic needs now and major purchases over the next three years. The unexpected happens, and you cannot risk investing when you may need to sell at a bad time to get the cash. The probability of personal economic shocks is higher when the markets are dealing with major economic shocks too.
You do need to indulge yourself and enjoy the journey. There is a balance. However, the earlier you can start your investing journey, the more protection for the future it will provide. You cannot control or predict market returns. However, a longer time invested means more compounding of those returns. Unfortunately, the only way to make up for lost time is to direct more of your money toward your security.
It is hard to make up for lost time. Learn & take action now.
Exponential growth means that delays now translate into outsized portfolio reductions later. Investing means taking risks. Investing wisely has a lower risk with a longer time frame. Do not try to make up for lost time by taking on excessive risks. Or worse, magnifying excessive risk with leverage. Especially, at a time when you are more vulnerable as retirement looms. Start early. Investing can protect you against inflation, premature retirement, excess taxation, and longevity risk. Not investing compounds those risks as you miss out on compounding returns. That is why you must learn the basics of investing and take action. Whether that is using my DIY Investing Hub to crush it on your own. Or to be a knowledgeable client and get the best out of your financial team.
Another great post !. Question 1-What determines the recommendation to hold 3-5 years of cash ? Is it because markets should recover in 5 years ? As you know there have been times of 10 years of flat returns ( maybe not globally but the 2000s in the US for example with 3 bear markets in 10 years ). Also does this recommendation pertain to a fully reired MD with no practice income as opposed to someone still in practice ? The adviser I deal with tells his retired clients to have 18 months of cash, but his focus is dividend paying equities so maybe he is factoring in growing dividend income ? , not sure.
Question 2- somewhat related. For years we heard about the end of the bull market for bonds ( from 1980/81) till it finally happened in 2022 where holding bonds did not help with portfolio diversification. When I looked at the Vanguard AA ETFs the difference between VBAL ( 60/40) vs VGRO ( 80/20) seem to show very similar returns over 20 plus years with a lot more volatility than with the higher equity ETFs so not worth the ride ? Perhaps you can incorporate this in your discussion in the future on SSOR and I hope you eventually talk about AA ETFs-one stop shopping in the context of accumulation and deaccumulation phases of ones portfolio. More homework for you ! Thanks
I said 3-5 years for saving because it could take less time to recover (in 3-5yr range) if you had a very conservative mix. By conservative, I mean 60-80% bonds (more aggressive could take a decade). Also, to overlap in that range an option would be to use bonds with a 3-5 year maturity. So, they mature when you need the money and you could ignore the prevailing interest rate fluctuations along the way. In the under 3-year timeframe, a shorter duration bond or GIC/saving option would be safer. All of those limitations are based on the premise that you have no other way to make up for some of the money not being there. In reality, many people could suppliment a shortfall from other pots of money or variable spending or a delay instead, to accept some degree of risk. However, I didn’t want to assume that. Advisors should hopefully take that flexibility into account. I am not sure how protective dividend-paying equities would be if you are depending on the income and capital appreciation. If just using the income, there is likely buffer there I would think. Dividends can get cut in bad times though. An interesting question!
The recent patch of stocks and bonds moving together is not unprecedented. I have a chart about half-way down this article showing periods of positive correlation, but I am sure a longer-term one would show even more. It is nasty for volatility when it does happen though and I should update it to catch the past year. Honestly, I don’t think I would change course. When using AAETFs, I like the idea of adding a second or third one as accumulating. That way, there are multiple options to choose from during decumulation because they would each have a different level of capital gain. Having a higher equity allocation (that matches my emotional tolerance) and then adding a bond ETF or building a GIC ladder in the 5 years on either side of retirement is another good way around the SORR issue (I think). I also like the idea of variable spending or some casual work in the sequence risk danger window. Lots of interesting options and I have some neat ideas for articles about AAETF strategies stewing 🙂
Thanks Mark, looking forward to them
Great post. My experience and words of warning.
Now appears a good time to go into long bonds.
So much can be done on your own without fees.
For my US$ accounts I’m looking at increasing 20 year US treasury with TLT ETF. Plus it pays dividend with expected capital gains over next years .
Also GIC ladder are good for short term. For moment I’m using money market ETF BIL and CMR/ZMMK.
Warning about fees and MD Management. Mom has a RRIF with MD and she was paying almost $3000 in fees a year for a RRIF of $120k. So we decided to just put it all in a brokerage GIC as it was getting 5%. You wouldn’t expect MD to charge fees on a GIC as they literally don’t do anything right ?
Well no, MD management came back as told her they’ll charge a 1% fee on a GIC. Can’t believe it.
So remember MD management in no way has the interest of physicians as priority. We’ll switch to TD self managed brokerage next year after getting away from MD management!
Thanks, Dad MD. The fees charged by various bank-model brokerages can be crazy and most people don’t even think to look. It usually shocks them when they do. People just assume they are there to help them, but they are businesses and largely sales-based when it comes to investing. We got my parents over from some major banks to Qtrade. Major savings and better service. They think I am a genius because they can see their accounts growing way faster, but is really just that they aren’t being eaten by fees. We just have them in a simple ETF portfolio.