Capital required for
a decent retirement

A well-structured investment portfolio provides adequate income and preserves the capital

By Jean-Luc Burlone

Today, the life expectancy of a healthy 60-year-old is 90 years. Hence, retiring at 60 requires the financial means to live for another thirty years. At current rates, one million dollars invested in a government-guaranteed bond for ten years generates an income of more or less $24,000 per year.

If that is not sufficient (considering governmental pension plans), either one dips into the capital or builds a portfolio that generates a higher return but with a higher level of risk. Such a portfolio would be structured to secure steady and decent revenue with an acceptable probability that the capital will be preserved to the end of life.

… a financial plan based on forecasts is bound to deceive. A better approach is to build a retirement portfolio based a person’s financial needs and time horizon.

Rates are low in North America, close to zero in Europe and even negative in other countries. Most predictions over interest rates are traditionally wrong as rates move unexpectedly at any time: they increase, remain the same, decrease anew or actualize all three possibilities within a short period of time.

Consequently, a financial plan based on forecasts is bound to deceive. A better approach is to build a retirement portfolio based on a person’s financial needs and time horizon.

Looking at statistics

Professionals have executed 70 observations of 30 years each from 1914 to 2014. They have estimated how various levels of revenue would impact a financial portfolio of one million dollars (50% fixed income and 50% equities). Their results are noteworthy.

If a 60-year-old retiree withdraws $40,000 per year (indexed annually for inflation) from the portfolio, there is a probability of 95% that he will leave an estate at his death in 30 years. If withdrawals are between $40,000 and $80,000 per year, the probability of leaving an estate remains over 50% but the capital will decline. If the amount is over $80,000 per year, the capital will decline to $0 within 30 years but we do not know exactly when.

‘The equity portion must be selected carefully according to the retiree’s needs and time horizon. Capital should certainly not be thrown to mutual funds.’

After simulating different portfolio structures, a one million dollar portfolio with 20-25% fixed income and hence, 70-75% equities is probably the ideal mix to secure decent revenue for 30 years while leaving an estate.

The equity portion must be selected carefully according to the retiree’s needs and time horizon. Capital should certainly not be thrown to mutual funds.

The right share

Shares can answer different expectations. In the field of technology, a minority of startups see the value of their shares increased many folds within a few years, though the company makes no profit year after year. This is speculation – which can be very profitable if you have the right skill – however, picking the winning company is not an exact science and most of these startups disappear after a few years or after a correction.

To provide a stable income and to protect its capital, the savvy investor would prefer the share of a company with a good capital structure (debt/equity ratio) and a stable and sufficient cash flow to pay the interest on the debt and to distribute dividends to shareholders. In addition, these types of shares respond well to the unavoidable market correction.

‘… a well-structured portfolio provides a stable income and preserves capital despite market fluctuations.’

Take a $100 share that pays a dividend of $4.00, i.e. a return of 4%. A correction of 20% will lower the price of this stock to $80.00. Its dividend of $4.00 will then represent a return of 5% ($4/$80*100). Seasoned investors will take advantage of this opportunity and bid for this share until its price returns to $100.00 and its yield to 4%.

This explains why a well-structured portfolio provides a stable income and preserves capital despite market fluctuations.

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