How to avoid the financial ‘Age of Ruin’ in retirement

Managing sequence risk and the order of returns

When we think about our long-term goals, retirement planning usually ends up front and center. And for good reason. Planning for life after work doesn’t just affect the retiree, it can influence the entire next generation.

When someone reaches retirement without enough savings, the responsibility often shifts to adult children, siblings, or even nieces and nephews. To avoid placing that kind of weight on your family, it helps to think of retirement planning as the financial equivalent of packing for all seasons: You’re preparing for sunshine, rain, and the occasional storm.

Because retirement planning stretches across a long timeline, it can feel overwhelming and, well, all-encompassing. The good news is that during the accumulation phase of your financial life (the years when you’re focused on growing your portfolio), time is on your side. The longer your investment horizon, the more likely markets will deliver the expected returns.

But things shift once you transition into retirement and start drawing income from your portfolio. Suddenly, the rules flip. In the withdrawal phase, the biggest concern, which doesn’t get nearly enough attention, is something called the “Age of Ruin.” That’s the point when your savings run out and you no longer have the money to live the lifestyle you want. Not exactly the milestone anyone’s hoping to celebrate.

The Age of Ruin can emerge for a variety of reasons: living longer than anticipated; experiencing periods of market volatility; unexpected inflation; or needing to make unexpected withdrawals to cover unplanned expenses.

Unfortunately, a retirement portfolio is not an endless reservoir; it should be viewed in the same way as a pension. You wouldn’t request an extra-large payout from the Canada Pension Plan nor would you expect a private pension administrator to offer a lump-sum withdrawal on demand. Pensions are structured to provide stable, predictable monthly income for life, built on actuarial assumptions designed to ensure sustainability.

In many ways, your retirement savings warrant the same treatment. Viewing your nest egg through the lens of a lifetime income source rather than a flexible pot of money can help safeguard it against premature depletion and extend its ability to support you throughout retirement.

Managing sequence risk and the order of returns

Having outlined the nuances of retirement planning, the next step is to focus on the specific factors that shape a successful retirement strategy. From an investment standpoint, the greatest Age-of-Ruin risk comes from what is known as the sequence risk.

Sequence risk refers to the danger that arises when the timing of investment returns collides with systematic withdrawals. Consider a retiree drawing monthly income from a portfolio: If the portfolio is not generating enough cash flow to support those withdrawals, the portfolio manager must sell securities to cover the shortfall. This becomes especially problematic when sales occur during market downturns. Ultimately, sequence risk underscores how crucial the order of returns is because poor performance early in retirement can have a more detrimental impact than similar losses occurring later.

Our approach is to frontload an income portfolio with low-beta blue-chip companies that distribute above-average dividends and that generate sufficient profits to comfortably maintain their current payout. The objective is to generate at least 70% of the retiree’s required income from the cash flow from the attendant securities in the portfolio.

The key component in this analysis is the dividend. Typically, one should look for companies that have steady income and above average dividend coverage. Dividend coverage which is typically expressed through the Dividend Coverage Ratio (DCR), measures how many times a company’s net income can cover the dividends it pays out. In other words, it answers the question: “Does this company earn enough to sustain its dividend?” What we are looking for is companies that can comfortably meet their dividend obligations without straining the finances.

Having a mix of secure dividend payers, we then focus on companies that typically increase those payouts over time which provide some limited inflation protection.

Richard Croft is Founder, Chief Investment Officer, and Portfolio Manager of R.N. Croft Financial Group Inc.

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R N Croft Financial Group Inc. is a Licensed Discretionary Portfolio Management and Investment Fund Management company serving investors and investment professionals across Canada since 1993.

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