PARTICIPANTS
Éric Hallé
Guest Host, Eastern Canada Regional Vice President
David De Pastena
Vice President of Portfolio Solutions
Éric Hallé: You're listening to On the Money with Dynamic Funds, a podcast series that gives you access to some of the most seasoned portfolio managers in active management and thought leaders in finance. During our meetings, we ask our guests relevant questions to get their perspective on the situation and to get their advice on how to work with the current context. Welcome to our podcast, On the Money. My name is Éric Hallé, Eastern Canada Regional Vice President for Dynamic Funds and I host the French version of the series.
Today we will explore the challenges investors may face as they approach retirement. Retirement can be an exciting new chapter in life, but it also comes with its own set of unique financial challenges. With the help of our guest, we will delve deeper into topics such as risk management, maximizing retirement income, and navigating market fluctuations. To help us navigate this critical phase of our financial journey, we are accompanied by Mr. David De Pastena.
David has over 20 years of experience as a client advisor and in institutional asset management. Over the past nine years, his focus has been on working individually with more than 500 financial advisors and helping them systematize their investment processes. He also has extensive knowledge of portfolio composition and specialized investments. Mr. De Pastena holds the following titles, CFA, CMT, CAIA, CIM and the FCSI. Hello, David.
David: Hello Eric, it's a pleasure to be here.
Éric: David, how do you think retirees are feeling these days in the face of rising inflation and market volatility?
David: We can't deny it, Eric. 2022 was quite a difficult year for everyone, but I would say especially for pre-retirees and retirees. There are statistics that show us that everyone is more afraid of being short of money than of dying right now. It's quite serious so I could give you another statistic, around 3/4 of the world are very uncomfortable with their financial situation here in Canada. Investors in general are very uncomfortable, but even more so the pre-retirees.
Because if we look at the situation for a pre-retired last year in 2022, they have been in a constant and balanced portfolio, then if they have had returns from a balanced portfolio in general, they may have lost 15, 12, 13% in their portfolio. For someone who's five years away from retirement, if we look at a plan and then they are five years out of retirement, let's say they're 60 and they're going to retire at 65. With the returns of the past year they are possibly forced to extend their retirement by three, four, five years. At the same time, we see this in a situation where inflation is much higher than in recent years.
We must not forget inflation, it is quite important because we talk about inflation, but the reality is that we have less if our income is not indexed. The quality of life can get worse. If we continue with a fairly high inflation of 4-5% after 10 years, we have half the means to buy anything. It means that our quality of life is diminishing. All this leads to the fact that the pre-retirees are getting scared. Retirees are afraid of running out of money. It makes the situation and the world quite uncomfortable.
Éric: Thanks for the context, David. When you talk about being more afraid of running out of money than of dying, I think it shows a rather extreme scenario. Then, you mention extending retirement by possibly three, four, five years. Those are certainly not words that people would like to hear. Why do you think retirees run the risk of running out of money?
David: Eric, there may be several reasons why someone may run out of money, but I'm going to take a few that are the most important in my opinion, which are spending, volatility and life expectancy. These three are the factors that contribute to either a lack of money or having enough in retirement. We must always consider them, these factors are important for retirees.
Éric: David, you mentioned three reasons: expenses, volatility and life expectancy. Could you tell us a little bit more, elaborate a little bit on what you mean by life expectancy?
David: I have some good news for you Eric. According to experts in biotechnology, and in life expectancy, we will live longer. Just in the last 100 years, life has been extended by 50%, which is good news for everyone. Even experts, those who work in biotechnology, or genetic development, this is a fascinating sector in terms of what is being developed. Experts predict that humans will live-- there will be 7 times more people who will live longer than 100 years. Seven times means a lot more people on earth will live longer. We must never forget two things that must be considered.
There is life expectancy and then there is health expectancy. Just because we're going to live longer, it doesn't mean our health is going to be at its best. It's important to think about it because it implies quite high stakes. First, if we live longer, for example, I believe life expectancy is at 82 years for a man and 85 years for a woman, on average. If we live 15 more years, for example, we live to 100-130 years, we must not forget that if we have a disbursement portfolio, then we live on our portfolio, we must practically double our returns and the expectations of returns.
Life expectancy, to live longer, brings a stake implying the need for more efficiency, otherwise it does not last too long. The other thing is, if we live longer, I talked about health expectancy. We must not forget that we live longer, it means that there is a good chance that our spending in our last years, for example, the last five or ten years, will be much higher. For the simple reason that our health care needs are going to be much higher, especially in a public system that is quite saturated.
Éric: Thank you David. If we mix the volatility of the markets a little, what could you explain in terms of how and why this volatility may influence the portfolios of retirees?
David: That's a very good question because volatility is a factor that can mean the difference between succeeding and not succeeding in retirement. One thing that is important is that volatility has increased in recent years to reach the same yield. It's a bit difficult to conceive because we had an incredible market increase from 2016 to 2021. There was an expression of economy. We must not forget that if we look at the statistics to achieve the same return, the volatility measured by the test cases has increased.
If we look, and if you don't believe so, look at the last five years, the corrections, the market declines are much more violent, so it means that they go down much faster and are much more frequent than they were in the 80s or in the 30s and 40s, anyway. There is a significant increase in volatility. The reasons why this happens, there are several reasons. One of the reasons, I believe, is the participants in the market. We see it right now, we saw it in 2021, we see that this or that person, anyone can go into the market and change the market.
We saw that with the MIM Stock in 2021 when young people who were investing in the different MIM Stock changed the market. They even put some hedge funds out of business. Participants are important. If we look at the participants, we see that a lot of the market volume and stocks trade, for example the S&P 500 in the United States, we see that there are a lot of robots and artificial intelligence. This means that the volume is much higher because of this type of system. There is what they call high frequency trading that makes it increase the volume in a big way.
By increasing the volume of the market, we have more volatility. That's one of the reasons. There are several other reasons, but this is one of the reasons why the market is perhaps more volatile, and then is going to be more and more volatile in the future. The problem is that volatility for a period of decumulation, so a portfolio of someone retired who disburses their assets. For example, they have built an accumulation portfolio for 40 years, then after that, they become a pensioner or they are 65 years old or whatever the age and then they disburse their assets. When you mix withdrawals with a decumulation portfolio with volatility, it's dangerous.
If we look at the research, what is important? Not necessarily the investments. What is more important? Sometimes it's when we retire. Because the reality is that we do not know 20 years in advance if the first day of our retirement is a period of decline or rise in the market or if it goes sideways as we say in English. We don't know what will happen in the future.
For example, if you retired in 1937, your assets didn't last long because it was a declining market. If you retired in 1980, your retirement portfolio went up, but we didn't know that 20 years in advance. It must be assumed that the markets will be increasingly volatile. We must assume and then put in place a strategy that promotes and no matter what happens, we have to be careful, no matter what happens in the market, we are prepared for it.
Éric: What I take away from your words, David, is that increased volatility and a start of disbursement can be a potentially very dangerous combination for retirees. With regard to expenses, what are the repercussions on retirement and what elements should retirees take into account?
David: To answer those questions, I'll use my experiences from when I was a financial advisor in 2001, a long time ago. In my day, when we gave advice, the rules were simple. We assumed that you just needed 70% of your income in retirement and you were okay and we also assumed that at 65 until 75, you spent the most, then from 75 onward, you stayed at home, you did not travel, all that. Today, there are many things that have changed. One, the baby boomer generation who are retiring today, they have a much higher level of debt than their grandparents.
It may be that part of our retirement income needs to pay off a debt. That means we need more. Also, there is the famous 4% rule. It is important to know that if we consider 4%, meaning that if we reduce the capital by more than 4% per year, 40,000/1 million, we increase the risk of running out of money more and more. The other factor is the health care factor. I talked about life expectancy, I talked about health expectancy. If we look at today, then I will give an example of my real life, my mother, after having unfortunately lived through what happened for our seniors in 2020 in the retirement homes.
She didn't like the situation. She didn't like what she saw. She asked herself, “Do I have enough money? Will I need more for my health care and my long-term care? " The expenses, the rules of the past, they may need to change if we haven't already changed them. We have to consider, one, how we go into retirement, two, what are our plans in the last few years, then what would we like to have as a quality of life? This can greatly affect our spending, obviously, if our assets will extend to the end of our days. These are quite important factors. We must always review what our expectations are within our financial planning.
Éric: Thank you David. Given this situation, what can retirees do?
David: Eric, I'm going to propose an idea that I call pantry versus orchard decumulation. For example, if we look at the pantry philosophy, I know it sounds interesting, that there is a philosophy around a pantry. When you're hungry, you eat everything in the pantry, then when there's nothing left, there's nothing left. This is sort of the tradition in the phases of decumulation that are happening at the moment. That means we're going to take our investment portfolio, then we're going to disburse, then if there's nothing left, there's nothing left. If volatility gets mixed up in all of this, it increases the odds that we're running out of money.
Maybe I should move on to the other strategy. The strategy of the apple orchard. For example, we're going to take the apples every spring, and then we're going to eat them, but our trees are still there. Every year, it stays constant, we can always eat perpetually. It's the equivalent of having a portfolio that you don't necessarily make withdrawals from, but that's a cash flow. We invest in assets. I call it a portfolio that generates a paycheck, that generates income or biological cash flow, investments that generate that perpetually.
What's going on? It gives us the opportunity to have an income of 40,000, 50,000 out of a million without ever touching the capital. Capital can fluctuate, obviously, with the market, but it will never affect all things that are constant in our income. On the other hand, if we approach the reality of retirement with the philosophy of a little pantry where we make a withdrawal, when we make a withdrawal mixed with volatility, as I mentioned, we enter a situation where we increase the chances of running out of money.
I propose to the World to consider it relevant, a strategy to say: "If my portfolio can distribute income biologically, investments generate this income, perhaps we can reduce the chances of running out of money in retirement.”
Éric: I think we'll all remember the analogy. So we have to eat apples and keep the apple trees versus emptying the pantry. For that, David, I thank you for your time and opinions.
David: Thank you Eric.
Éric: As shown by our motto “Invest with advice”, we encourage investors to team up with a qualified advisor. Thank you for joining us. Have a great day and see you next time.
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