Most investors believe their time horizon refers to the date when they will no longer have to grow their investments. They believe this because it is what their financial advisors have told them. Investors should understand that it is in the interest of financial advisors to say this, so they can keep a client in higher-risk securities for which they likely receive greater compensation. Simply put, the longer financial managers handle these investments, likely the more money they make.
The investopedia.com dictionary defines time horizon as “the length of time over which an investment is made or held before it is liquidated.” According to James Bagnall of the Globe and Mail, a better definition is the length of time between when the client wants to grow funds and the time the client has to live off the income from those funds. In other words, investors need to realize that this time horizon is really the span of time they are taking on risk to grow their funds. A new time horizon starts when they know will need income from the past growth.
The Conflict of Interest
How much growth is “growth”? If you own a portfolio that increases by 5% each year, do you care whether you actually receive 5% in cash from interest payments, or whether the value of the securities increases by 5%? You would care if the tax consequences were different, as they can be. However, if your holdings are within a registered plan, such as a Canadian RSP or an American IRA, you would not care, because there are no tax consequences either way.
Regardless, what you need to know – and what your financial advisor has a professional obligation to explain to you – is that your risk of loss increases with your hoped-for percentage gain. If not explained to you, how can you fully understand the trade-off between the real risk and the potential reward? Failure on the part of financial advisors to make the explanation comes from a conflict of interest – your interest in having appropriate investments that work for you, and the advisors’ interest in continuing to manage high-risk investments that work for them! A professional advisor will put the interest of the client first, and make suitable recommendations after full explanation of risk.
The Myth of Inflation
In reality, the shorter an investment time horizon you have (i.e. before you have to access your money), the less risk you can afford to take. If you need $50,000 a year to live on, and receive $10,000 a year from pensions and other sources, you will need $40,000 a year from investments. Your financial advisor may warn you that the $50,000 requirement will increase with inflation. What your financial advisor may not add is that retired people often do not suffer the consequences of inflation the way working people do, because many of their expenses are no longer tied to the cost of living.
For example, many retired people have paid off the mortgages on their homes and have already invested money in upgrading and maintaining them. Therefore, they do not have to worry about any increase in housing costs, except to the extent that real estate taxes and house operation costs increase. House values may well increase faster than those costs.
Also, as retired people age, the cost of social and recreational activities may decline. They may continue to travel, but going to stay in one place in the sunny southern United States or the Caribbean will be far less expensive than the trips across Europe or elsewhere they took when they were younger. Pension incomes may increase with inflation, and government subsidies may kick in. Granted, increasing health care needs may be a factor, but many people continue to have health insurance benefits that carry over into their retirement. Government subsidies for health care increase with age.
The Risk Factor of Age
The older investors are, the less time they have to make up losses. They also have fewer resources to draw on should a loss reduce their account. They may suffer severe family stress, as their investments decline and they see their goals slipping out of reach. It is their financial advisor’s obligation to protect them by knowing their situation and needs, by setting appropriate financial goals, and by keeping their investments secure.
To put it clearly, investors who have substantial stock market exposure should consider making changes in the risk factor of investments as they approach and then pass the age of retirement. Their advisors have a professional obligation to advise them to take less risk.
If your financial advisor has not fulfilled this obligation, you have the right to complain to your provincial securities regulator and to retain legal counsel. For a free consultation, please complete and submit our online form.