No one wants to run out of money while in retirement.
So what can you do to ensure that you never run out of money AND are able to maintain your quality of life well into retirement?
Plan… and plan early.
Here’s 5 key considerations that everyone needs to think about.
Reviewing these throughout your career, and in the retirement planning process, is your best bet to ensure a happy and relaxing retirement.
1. Consider how long you’ll need money for – a prudent retirement plan should account for a 30+ year retirement window.
Don’t run out of money before you run out of breath. Statistics Canada lists the life expectancy for 65-year-old Canadians as 21 years (19.5 years for Males and 22.3 for Females as of 2017).
In 2013 it was 20.7 years.
Depending on your socio-economic position, and geographic location this number is higher.
I encourage my clients to safely plan for 30 years+ of income needs.
2. Consider inflation and the rising cost of living.
The CPI index, Canada’s measure of the increase in cost of living, has increased from 86.1 to 137.4 from Jan 1991 to Dec 2020. That’s an increase of over 60%.
Therefore, if your money as a retiree wasn’t growing by at least 2% per year between then and now, it was shrinking… and this was during a stretch of relatively low inflation.
3. The risk that the rising cost of living presents is dangerous.
Why? Because it doesn’t jump out and shock you. It slowly creeps up until you’ve lost your ability to afford the lifestyle you’re used to.
On the flip side, I often see many retirees that don’t actually increase their spending each year with inflation so it’s also wise to consider not being too conservative in the early years while you have your health and your wealth.
CPI Index taken from Stats Can: https://www.statcan.gc.ca/eng/start
4. Consider Investment Risk & Returns
Investment risk can only be transferred and planned for – it cannot be eliminated.
As you get closer to retirement, it’s usually best to reduce higher risk investments because a higher risk investment that falls doesn’t necessarily go back up, especially if you’re drawing or close to drawing income from it. Example, an investment is down 10%, the retiree draws 5% for spending and now the investment is down 15% overall. If you’re down 15%, you need close to an 18% return to get back to even.
In bull markets investors tend to suffer from recency bias and focus on the return and not the risk, but it’s not always the case that a risky investment will come back up after a loss.
Investors with guaranteed income in the form of pensions may afford to take more risk with investable assets than those relying more heavily on their investment portfolios alone.
When you’re still working in early or mid-career, you have decades to recover from drawdowns in a higher risk portfolio. In fact, as a younger investor, bear markets are a great opportunity to buy more and more shares/units at lower prices.
GIC’s, Bonds, and Cash, often perceived as ‘safe’ investments, aren’t so safe viewed over a long period. They can suffer real purchasing power loss to inflation. Being too conservative is a big risk.
Lastly, consider the risk of private market investments that don’t display day to day price fluctuations. These investments still have the same economic risks associated with public markets, as well as manager risk and liquidity risk. Sometimes these investments look great until one day they aren’t. They can be a great addition to a portfolio, but they are less transparent and the due diligence needed on these is high.
If you’re not sure how to construct your portfolio in preparation for retirement, it’s best to work with a Certified Financial Planner who has years of experience doing exactly this.
5. Probability
Just tell me the number already!
Most of my clients want to know exactly what percentage they can withdraw from their portfolio each year to ensure they never run out of money.
Well, it’s generally somewhere between 2.5% and 5% depending on how bullet proof you need it to be.
This means for someone with a $1 million portfolio, the amount you can draw from it each year (ignoring tax) is between $25K and $50K, assuming an appropriate, suitable and well diversified portfolio.
Why such a wide range?
We don’t know ahead of time if we’re retiring right before the next great-depression, or the next multi-decade bull market.
If you want close to 100% chance that you will not run out of money before 30 years, a 2.5% withdrawal rate has the highest probability of succeeding, even if you get unlucky and face a big, prolonged bear market shortly before or in early retirement.
A withdrawal rate of 3.7% reduces your probability to 95% and 5.3% reduces it to 75%.
Source: https://www.morningstar.com/articles/1043706/the-hidden-assumptions-of-financial-calculators
Depending on your pension income, and other circumstances like real estate and debt, you can decide what probability you are comfortable with.
Accepting Uncertainty
Your planning has to be flexible to adapt to changes in life expectancy, lifestyle, market conditions, and many other variables. Life unfolds in ways we can’t imagine.
Ongoing monitoring and management of your planning is key.