Financial and Business Succession Planning, J. Paul Wilson, CFP, Halifax, Nova Scotia, Canada

This article is a recommended way for managing the effects of reverse-dollar-cost-averaging.
 
Accessing Income from Investment Portfolios

Most people believe that income should be drawn from conservatively invested funds. In some cases this may be appropriate. However, as Canadians start to retire earlier and live longer, the resources they are going to use for income may need to last 40 to 50 years. A fund too conservatively invested over 40 to 50 years may not perform according to your needs and expectations.

If you invest in a fairly aggressive strategy using a high component of equities, the day-to-day fluctuations in the market will create volatile asset values.

For many years, dollar cost averaging has been used to move money into markets that are volatile. The following chart illustrates the impact of this approach as markets move up and down. This discipline fights against the natural tendency to buy when the markets are high and sell when the markets are low.


 
If you now start removing level income each month, you get the following results. This is counterproductive because you end up taking out a greater percentage of your assets when values are reduced and less when the values are improved.



Wait a minute ...................

The final picture is what you really want to accomplish, and that is to remove more value when the markets are up and less value when the markets are down. A mechanism to accomplish this could be referred to as “asset value averaging”. By using a constant percentage of assets, the dollars removed from the investment fund when markets are up and will be much larger than the amount removed when markets are down.


 
Solution: Sell a % of asset value

 This asset value averaging approach sounds great theoretically, but most people don’t like to live with a fluctuating income. A “reservoir fund” can be established to receive these fluctuating income amounts and invest them on a more conservative basis using money market or income funds. Then, a constant dollar amount can be extracted from this much less volatile “reservoir” fund.


 
Depending on your risk perspective, the percentage of assets chosen to move money from your ongoing investment fund to the “reservoir fund” can be set at a reasonably high level or at a lower level closer to the target income that you intend to take out and spend. If a high percentage of assets are used, the reservoir fund will build up much quicker and provide a stronger buffer against market changes over short-term cycles.

For convenience, you may want to transfer a percentage of the assets at the end of each year and then draw constant income on an electronic transfer basis from your reservoir fund.

 If you moved a fixed percentage of the fund into a transitional fund, then paid out a pre-set amount of income, you would in effect, be reducing the effects of reverse-dollar-cost-averaging. It does require some manual effort to determine that amount each payment period and transition the money.

Alternatively, using profile or folio funds tends to have a natural built-in buffer since the mix is constantly being rebalanced. As one portion of the portfolio grows faster than the others, the rebalancing has the effect of selling off what is relatively higher and buying what is relatively lower. This constant rebalancing tends to reduce the volatility inherent in most static portfolios.

Theoretically this provides a more stable asset base from which to draw an income.

 Summary: 

• Asset value averaging – withdraw a constant percentage of assets

• To smooth fluctuations – use “reservoir fund” approach

• Use portfolio or folio funds – automatically rebalance

• Use a profile and rebalance accordingly

Systematic withdrawal plans are only part of balanced retirement income plan


J. Paul Wilson, CFP, CLU, CH.F.C., TEP
380 Bedford Highway, Halifax, Nova Scotia, B2N 2L4
Office (902) 405-8665 Direct (902) 982-2377 Mobile (902)488-4982
Toll-free Fax (866)-436-1207 Email paul@jpw.ca

Desjardins Financial Security Investments Inc.
Branch Office
110-230 Brownlow Avenue
Dartmouth, Nova Scotia. B3B 0G5
Branch (902) 468-0814
Direct (902) 982)-2377
Fax: (902-468-7292

NOTE:

The information contained in this article is intended to provide general guidelines only. The application and impact of the law can vary widely from case to case based on the specific or unique facts involved. Accordingly, the information in this article is not intended to serve as legal, accounting or tax advice. Users are encouraged to consult with their professional advisers for advice concerning specific matters before making a decision.

Make your investment decisions wisely. Important information is found in the funds' simplified prospectus. Please read this carefully before investing. Commissions, trailing commissions management fees and expenses all may be associated with mutual fund investments. Mutual funds are not guaranteed, their values change frequently. Past performance of the funds may not be repeated.

Desjardins Financial Security Investments Inc. (DFSI) is not providing the financial planning service and will not be supervising this activity. You should not rely on DFSI for review of the plan. DFSI is neither charging nor being paid any fees for this service and will not be liable for any errors or omissions. This Financial Planning Service is done solely through jpw.ca Insurance Retirement Investments.