In 1996, the annualized minimum wage in Ontario was $14,248. The 10-year government bond yield was 6.4 per cent. Doing the math, you needed $222,625 (about 16 years of earnings) in savings to earn a completely guaranteed equivalent to minimum wage.
In 2019, the annualized minimum wage is $29,120. The 10-year government bond yield is 1.7 per cent, which means you now need $1,712,741 to earn a risk-free minimum wage equivalent – or roughly 59 years’ worth of savings. Things have changed big time!
Two particularly tough things have happened to income investors in the last 23 years.
First, if wages reflect the cost of living then prices went up about two times (ouch). That hurts, but perhaps worse is that what you had to save to replace that in a simple way, such as investing in government bonds, has gone up 3.5 times.
There was a time when the accepted wisdom was to dramatically increase your bonds or GICs at retirement and then live off guaranteed interest. This simple strategy that worked just a generation ago can’t cut it today. The battle against inflation and outliving your income can no longer be won following yesterday’s rules.
There is really good and bad personal news that goes along with the new financial reality.
The good news is that we’re all likely living longer. The bad news is that we need to grow our incomes to fund our long lives, and we need even more growth than we used to. In retirement, we also need to figure out a way to get paid something reasonable while we’re growing our capital.
Today, there is a good chance you won’t be able to accumulate enough capital to get a reasonable income from a bond portfolio. At 1.7 per cent, $2 million dollars gives you $34,000 of income – not a very exciting number after the discipline necessary to accumulate the initial investment.
You can earn more, but the rules of risk and return always apply. Take stocks for instance.
We're told by Ibbotson (a firm that tracks market data) that the compound annual inflation rate in the United States from 1926 to 2018 was 2.9 per cent. At least since 1960 (and maybe even further back than that), the S&P 500's cash dividend has compounded at 5.9 per cent, or about twice the inflation rate.
This would appear to solve the problem, especially since the invested capital went up about 50 times since 1960.
Preferred shares can help. Enbridge, for example, pays about six per cent on some of its preferred shares, and, with the dividend tax credit, that six per cent becomes worth about the same as a 7.5 per cent interest yield. For most investors, some combination of higher-yielding income investments and some growth investments is likely sensible.
In a world where simple no longer works very well, a plan becomes of utmost importance, as well as a system to keep the plan on track. Our solution at Livingston MacDonald Wealth Management of RBC Dominion Securities has been to create the Watermark System. The Watermark System combines year-by-year planning, individualized investment policy and a defined process to keep you on track against your changing circumstances and priorities.
This article is supplied by Alan MacDonald, an Investment Advisor with RBC Dominion Securities Inc. Member–Canadian Investor Protection Fund.
Livingston MacDonald Wealth Management helps young professionals with $200,000 or more of investment assets articulate and execute smart financial plans. Visit us online to learn more about the answers you need.