PODCASTS

PARTICIPANTS

Daryl Diamond
Chief Retirement Income Strategist

David De Pastena
Vice President of Portfolio Solutions

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Presenter: You're listening to On the Money with Dynamic Funds, the podcast series that delivers access, insights, and perspective from some of the industry's most respected active managers and thought leaders. From market commentaries and economic analysis to personal finance, investing, and beyond, On the Money covers it all, because when it comes to your money, we're on it.

David De Pastena: Welcome to another edition of On the Money. I'm your host, David De Pastena, Vice President of Portfolio Solutions. Today we're going to take a deep dive into the paycheck portfolio approach for retirement income planning. To unpack some of these questions, my guest today is Daryl Diamond, Dynamic's Chief Retirement Income Strategist. He's also one of Canada's pioneers in creating efficient retirement income. He's got over 44 years of experience, and he's a bestselling author. Daryl Diamond, it's great to have you here.

Daryl Diamond: Thank you, David.

David: In talking about paycheck portfolios, can you tell us the difference between the paycheck portfolio approach and the traditional approach to creating retirement income?

Daryl: The secret, if you will, is all in the name, paycheck portfolio. Where this differentiates, David, substantially from the traditional, let's set up a portfolio, whether it's 60/40 or 50/50. Conventionally, what advisors are doing, what clients are expecting in a regular or traditional portfolio sense, is what I've referred to as the grow and sell approach. That unto itself is not necessarily a bad thing unless you run into periods of time like we've been in for the last 19 months where things aren't growing as one would expect them to do.

In which case, now all of a sudden, portfolio, the traditional way of doing it. Let me just use an example, a 60/40, 60% equity, 40% fixed income portfolio, or 50/50 in retirement is pretty standard, pretty traditional, and it's fine. There is a methodology when we hit volatility or negative markets. There are ways to abate the negative impacts of the returns, while at the same time you're taking money out. It's that terrible double drawdown scenario, and people dread that. Both by the way, clients and advisors dread that.

That's the traditional way. Let's these investments grow in value. We'll cull off some of the growth each year, and if you will, collapse it or surrender it or sell it, and that money will form the source of withdrawals we make from the portfolio. Again, I want to repeat that over any reasonable time frame, there's merit in that approach, but the paycheck portfolio approach looks at it from a different perspective.

What the strategy is in the paycheck portfolio is to, if you will, harvest the income that is generated by the investments that are held within the portfolio. Again, your asset mix is going to depend on the client sensitivity and the investor tolerance profiles that everybody has to complete as a regulatory perspective, but what you're doing is, if you will, drawing the income that is produced within the portfolio, using that as the source of funding the withdrawals that are to be made throughout the calendar year, rather than the grow and sell approach.

Just by that simple explanation, spend the income generated from the portfolio as opposed to sell investments in the portfolio, which is the traditional way of doing it. You can see right from the start that it's going to be a much less stressful approach for clients. It is going to be a scenario where we're not selling investments at times that markets and account values are negative which means, of course, we're selling them potentially at a lesser market value than they were prior to the downturn in the investment cycle, but it allows the investor to, if you will, spend the income, as we've said before, generated by the portfolio, not be selling investments along the way.

Traditionally, and I think this is a really important point, David, any type of quality investment that is owned, and I mean whether it's fixed income, whether it's equity, whether it's growth, whether it's value, if it is left on its own, if it's not disturbed, if it's not sold, even in periods of difficult markets and descending account values, if that money is left alone, it does eventually, I use the word heal. Get back to values that it was shown at previously, reflecting previously, and beyond, but the key is it gives us both as the advisors and as the client, this understanding that this is what we're going to do, we're going to draw this income as opposed to sell these investments. It's wonderful when markets are fine. It's even better when markets are challenging and negative as we happen to be going through right now.

David: That's really interesting, Daryl. What are some other benefits, maybe from the taxation side or anything else about putting a paycheck portfolio approach where we spend the income and not the capital?

Daryl: I think there's several different things that are important here. First of all, let me take it from the point of view as an advisor, having done this for 35 years and focused on retirement income. Talk about it from that perspective and also talk about it from the perspective of the client, the retiree, who's taking income from the capital that they've literally taken a lifetime to accumulate.

First and foremost, it has never been in my experience, and I'm speaking from our practice and our business when we had the business. It has never been the wrong thing to tell clients to stay invested, to maintain the plan as was created at the outset, along with the investment strategies that were specific to that client or that couple that we used to align with the plan in order to execute it over time.

All of these things work together, everything starting with, in our opinion, a really tailored and well-written retirement income plan, but from the point of view of the paycheck portfolio, David, I think the easiest way to explain it and give you the best answer to that question, is to actually talk about how we used to discuss this with clients. There may be listeners that say that's a very good way to explain it. Some may say it's not 100% accurate but conceptually, that's what we were going for.

I'll give you the example. If you were sitting across the table in our office where our building was in Winnipeg, right across the street, by sheer coincidence and convenience, was a duplex. We would say to people when we were first talking about the paycheck portfolio strategy, if instead of having stocks, bonds, alts, all of your retirement capital was tied up in that building across the street, and you funded your monthly retirement income from the rent checks that you received from your renters who are in that building that you own.

Now, if that is consistent and a sustainable flow of income, then that's very easy to understand. It's very comfortable for the consumer, for the retiree to accept and find that description of strategy something that they can understand very easily. That's a level of comfort.

Secondly, we would point out this. If that was your building across the street, and you were looking at the real estate news in the city of Winnipeg, which is, of course, where I'm located, and you saw all of a sudden that the market value of your duplex went down, of course, you wouldn't like it. I'm not saying it isn't important, much like the value of someone's investment portfolio is important, but the point here is this. Irrespective of the market value of that building going up or down, you had comfort as the owner of that property in knowing that that rent was going to be delivered each month, and that's what you were using to fund your retirement. You didn't have to worry about selling the building. If it was down in value, the last thing you would want to do is sell the building.

You would want to just sit back, wait, spend the income that was arriving, which was your retirement paycheck, hence, the name, and just let that building do its thing as it relates to market and value over time. As mentioned previously, quality property will appreciate over time whether it's stocks, bonds, alts, or whether it's the duplex we're talking about, but what the paycheck portfolio really allows the client to do with greatly reduced stress is have the patience to allow that investment capital, that investment property, whatever allocation may be, or whatever it may be, to sit and heal.

We're not disturbing it, we're not disrupting it. If we're using a mutual fund, we're not selling off units every month to create a paycheck. That's the big difference. That's a very large way of saying that, in my opinion, and there's different ways to approach this whole creation of retirement income. There's nothing that's perfect, but the paycheck portfolio checks a lot of the boxes, and mostly for the retiree, the three things that are really important in terms of both them being comfortable and enhancing the advisor relationship is that they can be comfortable with the approach. They can be confident, and we'll talk about the investments that we have found very useful in executing the strategy.

They can be confident given the history of the managers, because this is a managed process, who are looking after the investments and creating the income, the flow from the portfolio, and last but not least, it's understood. There's no fireworks and ribbons going all over the place in terms of flashy and glitzy. It's a concept that is sustainable, and that's huge for people in that retirement income scenario.

David: What are some of the key questions investors can ask themselves to put this in place? Because I'm sure many of the listeners are really curious on how to start to put this in place and where to start.

Daryl: First, let's reel it right back. It's essential that the consumer, the retiree have a really solid idea of what they're going to need in terms of cash flow on an after-tax bases. That's step number one. I think that in a lot of cases, insufficient time is allocated to that very important task. What is it that we want to create as an after-tax cash flow, and sometimes, we would see situations where people literally on their Visa card kept track of every darn dime that they spent prior to retirement on a month-to-month basis, and that was really helpful. It gave them a very solid insight as to what would be needed and it certainly helped us as the advisors, but that's number one. What is it the client needs is a cash flow?

Secondly, what do we have in terms of investable assets, and in fairness as well as income sources, such as CPP, and OAS, or pensions that may be present? What is it that we have in order to create that cash flow that people need?

When you look at the comparison of income that is required and the beauty of the paycheck portfolio is you can look at the income that can be provided from that strategy and compare those two numbers. It's a lot more accurate than-- and I'm just using an example here. We need $6,500 after tax per month, and in our household, we have investable assets of a million. Well, a million dollars is a nice number, but what does it mean? What does it mean as it translates to income?

David, I use the analogy from time to time again, and I just find this kind of discussion very helpful when I'm speaking to a prospective client and even reinforcing the idea with existing clients when I was an advisor, and it's just simply this, if you were driving from Montreal to Toronto, what's the distance?

David: About 500, 600 kilometers?

Daryl: Let's say that you're leaving your driveway, and you see that you've got three-quarters of a tank full of gas, and you're going well, that's pretty good, it's not full, but it's not half, it's three quarters, I should be fine, and for this little analogy, let's assume-- I know this is a stretch, let's assume that there are no gas stations between Montreal and Toronto, so what you've got a tank has got to sustain and last and get you from Montreal to Toronto. As you see that needle coming down, you might start to feel a little antsy as you're still always outside of Toronto, and you see the gas gauge tilting down. That's one way that it seemingly feels to me if people are looking at, well, I've got a million dollars, and I need 6,500 after tax per month from all sources.

If, however, your car has a gauge on it or display on it, that tells you your estimated mileage, given how full your tank is, that gives you a lot clearer picture, that gauge on your car says, you have a range of 725 kilometers, well 500 to 600, it's going to be very comfortable for you to sit back, enjoy the ride, and just cruise through it. It's the same way with money when we're talking about comparing income needed with the income that can be created, it's like looking at that distance side, Toronto, 600 kilometers, looking at the gauge in your car, you've got a range of 725 kilometers, that's the information you need to know, because ideally and practically, once you're stepping into this scenario called retirement, that's it, you're not going back to work.

This has got to be workable and it has to be sustainable, and comparison of those two numbers both based on income in the financial analogy are the same in my opinion is looking at the distance sign saying 600 kilometers, the gauge in your car saying 725, that tells you a lot more, and makes you a lot more comfortable and certainly enhances the journey over it's 600 kilometers to Toronto, and I got three-quarters of a tank of gas.

David: That's a great analogy. I love how paycheck portfolios kind of fill the gap on what you would like to have, what you have, and what's going to sustain your lifestyle. Is the paycheck portfolio approach just for retirees or can you implement this for pre-retirees?

Daryl: For pre-retirees, one of the big concerns that they have is the timing that they choose to retire, and I'm sure everybody has heard having a negative sequence of returns on your portfolio prior to or in the early years of retirement, that is a big fear, and can really disrupt everything going forward, if we're using the grow and sell strategy. Where the paycheck portfolio fits in beautifully, and we'll talk about fully retired people in a second, but especially for pre-retirees is this. If you have a paycheck portfolio that's set up, and primarily using those funds, those types of investment funds that distribute on a monthly basis, then what happens is, if you run into the years of flat or negative returns, you actually end up increasing the income you're going to have year by year, and at the point in time where you retire.

Why is that? It's because prior to actually making the withdrawals from the paycheck portfolio, when we retire, the pre-retiree is investing those monthly distributions, and anybody that understands dollar-cost averaging knows that if it's the same distribution every month, and the unit value is going down because markets are having a poor year or poor quarter, whatever the case might be, we're simply buying more units each month when we reinvest those distributions.

I don't mean to sound flippant when I say it, but for the pre-retiree, you almost want a bad sequence of returns before you retire because it bumps up your income that you're ultimately going to be paid, and that's a function of simply buying more units, and I think that's a critical point to make at this juncture. The income that you're receiving as a retiree when that time actually arrives, isn't predicated upon what's the value of my portfolio. It's based on how many units do I own, and what's the number of cents per unit being paid out monthly.

A negative sequence of returns prior to someone retiring, again, it sounds silly, actually increases the income that you are going to be receiving. It's not that the count value isn't important, of course, it is, but that is not what your income is predicated upon, as would be the case with the grow and sell strategy. For the pre-retiree, it gives a much more accurate picture, number one, as we talked about, with the gas gauge example of what's going to be generated relative to what do I need, and secondly, we've just really taken out the negative impact of a negative sequence of return happening just before retirement, and I think that's huge.

David: I'm just curious, how does the Dynamic offerings fit as an investment solution provider for the paycheck portfolio approach?

Daryl: David, as you know, I approached Dynamic, when we finished transitioning our practice and we're no longer advisors, to see if within the retirement income sector, there was an opportunity for me to participate as someone who not only fully respected and appreciated the direction of information, this pivot to a portfolio paycheck strategy, primarily as a way of moving forward, but it was what we did in our business.

The things I'm talking about, this really drove the building of our business in the last 12 or 13 years that we had our practice, and Dynamic was a huge part of that. I'm the first guy to say that there were some other offerings that we use from other investment firms, but Dynamic traditionally, always the core of any portfolio we were setting up, and that is because we fully respected the ability of the managers to deliver on what they had said they were going to deliver.

Through the period of time that we use the Dynamic offerings, there was never a time where the number of cents per unit per month changed to the downside. We had a couple of increases, which is great, but it was the performance of the managers of the Dynamic offerings, those offerings that distribute a set number of cents per month per unit that we call them target distribution strategy or monthly distribution strategy before we adopted the name that Dynamic put forward, which I think is brilliant, and that's the paycheck portfolio is because it's just is so clear and what the intent of the strategy is, and our history with Dynamic, the length of time that these investment positions have been in place, and the consistency, which is what anybody taking income is looking for, the consistency, I mean, you look at the track record of Dynamic, and both the breadth of shelf, the depth of shelf, the history of these offerings, and how well they have performed. This may sound a little biased, but if there's someone else out there offering a greater selection of choices, I haven't run into it.

As the opportunity to align with Dynamic presented itself, I knew what they had done for our clients, what they had done for us in terms of helping us build our business. I mean, you've got everything here, whether it's specifically equities, whether it's foreign, domestic, bond offerings, alt offerings, beautiful to combine and manipulate, and I mean that in a good way in terms of allocation, so that you have a distribution that is meaningful to the client. It's not about creating the highest distribution; it's about creating one with a proper asset mix that fulfills the needs of the client. Again, I bring it all the way back to what we talked about earlier, allows them to be comfortable and confident in the sustainability of this approach.

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David: Thanks, Darryl, for digging deep into the paycheck portfolio approach. This is another edition of On the Money, and on behalf of all of us at Dynamic Funds, we wish you all continued good health and safety. Thanks for joining us.

Presenter: You've been listening to another edition of On the Money with Dynamic Funds. For more information on Dynamic and our complete lineup of actively managed funds, contact your financial advisor or visit our website at dynamic.ca. Thanks for joining us.

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