Looking ahead to retirement: we're living much longer than our forebears, but this is only good news if you've got a watertight financial plan.With life expectancy almost doubling in the past 100 years, today there is a 40 per cent chance that one partner in a 65-year-old couple will live to the age of 90. For many people, that involves planning for a retirement of 25 to 30 years.
Additionally, planning may involve some degree of financial support for your parents. Whereas in 1900 there was a 7 per cent chance of a 60-year-old person having at least one parent still alive, by 2000 that probability had risen to 44 per cent. (1) Some of us may contribute financially to the support of our adult children, as well.
No one really wants an answer to the question of how long we or our loved ones will live ... few of us even want to consider the question ... but not planning for various eventualities is a recipe for disaster and heartbreak. In planning for an unknowable future, ifs crucial to build flexibility and sustainability into our personal financial blueprints. Let's look at a few planning considerations.
What effect will inflation have on your living costs over time?
Let's say that you are currently living on an annual income of $100,000. Research suggests that you will require 60 per cent (2) of that amount, or $60,000, in your retirement. Assuming that inflation continues at 3 per cent per year, in 20 years the buying power of your $60,000 would be reduced to $33,000; and, over a 35 year retirement starting at age 60, to $21,000 by age 95.
Obviously, your plan needs to find a way to counteract the negative effects of inflation.
Why should you bear the discomfort of market volatility?
The years spanning age 20 to age 60 are typically a time of accumulating assets. Your ability to handle risk decreases over this period, from the early years when you can handle significant volatility to the time approaching retirement when you will require an income from your portfolio and can therefore withstand much less risk.
If eliminating market risk were the only concern, you could address it by purchasing guaranteed investments. However, guaranteed returns can seldom offset inflation over the course of a long retirement, so some portion of your investments must be allocated where they can grow faster than the rate of inflation. In other words, they must be exposed to market risk.
Assuming market risk means accepting the discomfort of a certain amount of volatility, with 2008/2009 being an extreme example. Typically, in one of every three years, a portfolio of stocks has a probability of a negative outcome. Over the course of 10 years, a stock portfolio could anticipate returns in six of those 10 years between -2 and 22, and in nine of those 10 years between -10 and +30. So, outcomes below -10 or above +30 could be expected in one year out of every 10, or 10 out of every 100 years. The portion of your portfolio that is built to protect you against inflation for the duration of your life must experience this type of volatility in order to achieve its expected returns.
The risks we face as we approach retirement play oft against each other. Avoiding market risk by reducing our exposure to stocks has the effect of reducing our expected returns, thereby increasing our exposure to inflation risk and the risk of outliving our money. By recognizing these competing issues, we can plan for them accordingly by structuring an investment portfolio to provide for us in retirement.
A properly constructed portfolio is a result of a planning process that takes into account your retirement needs and your capacity to handle various risks. Products such as tax-efficient investments, annuities, inflation protected products, and so forth can help mitigate some of these risks. However, focusing on products or current market conditions can distract us from making sure we are tracking to our long-term plan. Short-term thinking tends to drive portfolios to take on more risk than necessary during upward moving markets and to reduce more risk than necessary during downward moving markets. During times of market volatility, we must keep in mind that this 'volatility' is the price we pay in order to achieve long-term outcomes that offset the risks of inflation and outliving our money.
The information contained herein was obtained from sources believed to be reliable, however, we cannot represent that it is accurate or complete. This newsletter is provided as a general source of in formation and should not be considered personal investment advice or solicitation to buy or sell any securities. The views expressed are those of the author and not necessarily those of Assante Capital Management Ltd. Before acting on any of the above, please make sure to see me for individual financial advice based on your personal circumstances.
(1.) CRS Report for Congress Aug 2006
(2.) Spending Patterns in retirement--Russell Investments
Daryn G. Form Senior Financial Advisor, Assante Capital Management Ltd. Daryn Form is a Senior Financial Advisor with Assante Capital Management Ltd. providing wealth management services to principals of family-owned and privately held companies. Assante Capital Management Ltd. isa member of the Canadian Investor Protection Fund and is registered with the Investment industry Regulatory Organization of Canada.