Japan and your retirement

Article

Richard Morin

Update :

May

2024

Update :

May 3, 2024

Earlier this year, the Japanese stock market finally returned to the peak it had reached in 1989, before the speculative bubble in equities and real estate burst. Poor Japanese investors suffered an 80% drop - from 1989 to 2001 - and had to wait 35 years to recover their invested capital! Can you imagine the impact on the unfortunate Japanese who retired at the end of the 80s, planning to live off their investments?

My friend Ando San

To get an idea, I recently reconnected with my old friend Ando San. Ando is 95 and in his right mind (the Japanese live a long time!). He retired in 1989, at the age of 60, with a portfolio worth $1 million, from which he planned to draw a pre-tax income of $36,000 a year, indexed each year for inflation, to supplement his old-age pension. Without wishing to rub salt in the wound, I asked him how his retirement had gone over the past 35 years.

Very well, he replied!

First, Ando pointed out that, including dividends, the Japanese equity portfolio recovered its value well before this year. In fact, it's more like 2020. That's already a bit better. However, a quick calculation indicates that - given the drastic decline in the value of the equity portfolio in the early 90s and its regular withdrawals - it would have run out of money in 2002, even taking dividends into account.

A balanced, diversified portfolio

But Ando was a cautious investor who followed his financial advisor's recommendations and invested 60% of his portfolio in bonds and 40% in equities. At the time, investing in bonds in Japan was a leap of faith. Indeed, they had performed very poorly in previous years because the central bank had raised interest rates to combat inflation. Disciplined as he was, Ando continued to buy bonds when prices fell, in order to reach his target of 60% of his portfolio by the time he retired.

Good for him, because - just as the speculative bubble burst and equities began their long decline - Japanese bonds benefited greatly from the secular fall in interest rates in Japan since 1989. Every year, he sold a few bonds - whose value had risen considerably - to secure his retirement income. He also took the opportunity to buy stocks whose prices had fallen, in order to maintain his weighting of 60% bonds and 40% stocks. Thanks to his balanced portfolio, Ando achieved an annualized return of 2.7% from 1989 to 2024, providing him with an annual pre-tax income of $36,000, indexed to inflation. In fact, his portfolio is still worth $334,570 today.

Ando San's advice

I asked Ando San what advice he would give to investors currently on the eve or cusp of retirement. His answer: prudence, discipline and patience are the keys to success. Of course, success is also the result of a sound investment strategy, based on diversification and balance.

Diversification

Even if we hold all the stocks listed on our stock exchange, the level of diversification is insufficient to properly manage risk. This is particularly true of the Canadian stock market, which is heavily concentrated in the financial, oil and resources sectors, or the U.S. stock market, which is dominated by technology and communications.

By adding foreign equities to his portfolio, Ando San would have exhausted his investments in 2008, rather than 2002. Diversification is therefore useful, but generally insufficient to protect capital and ensure regular income. The portfolio must therefore be balanced with bonds.

Balance

Adding a healthy dose of bonds to his portfolio has enabled our friend Ando to achieve his financial goals and ensure a comfortable retirement. Note that a portfolio of Japanese equities and bonds would have been insufficient, as he must also hold foreign equities.

Some may think that 60% of bonds in a portfolio is a lot, even for a retiree. But let's not forget that Japanese bond yields were around 5% at the time, and equities were trading at 60 times earnings. In such a context, it makes perfect sense to invest 60% of your portfolio in bonds.