I have frequently been asked the million-dollar question, “How much will I need to retire?” Most people don’t complete the question, but there is usually a second part: “…and maintain my current pre-retirement lifestyle.” Lots of advisors present flashy charts and graphs showing “exactly” what you will need and when funds will deplete. The problem with all that information is that too many pieces of important information are missing.
The exercise is really an educated guess based on the information available at one point in time. This is why it important to make semi-annual or annual visits with your financial advisor, just as routine as your regular visits to the dentist. As time passes, adjustments can be made so that you won’t outlive your capital.
The data for future income are usually pretty accurate, because pension income, CPP, OAS, and RRIF funds can give you a pretty complete picture from the income side. The big unknown on the income side is the investment return.
There are also many more unknowns on the other side of the balance sheet – the expenditure side. Some of these include:
Spending: It will take six months to a year to really see how your spending habits change into retirement. Do you actually drive less (therefore use less gas) without the commute, or is the driving more or less the same? People can spend vast differences depending on their lifestyle. As Craig Alexander, chief economist at TD Bank said, “If you are happy sitting on your porch reading the newspaper, you need a lot less money.” Compare that with somebody who goes to Europe every two years plus Mexico, Arizona, or Hawaii every winter. That’s why your plan is your plan. Your investments are your investments, not for your neighbor or colleague with different age, goals, and spending requirements.
Healthcare: This one usually creeps up as you age, so in the first 10 years, these expenses might not rise too much. But they will escalate over time. Depending on your retirement benefits, many of these expenses will come from your own pocket. I have had clients who spend $1,000 a month on various medications. We can’t know in advance when or how health problems might affect us, so it’s impossible to know these costs in advance.
Social activities and travel: Many people plan to travel a lot in retirement. But come the long-awaited day, they find that in fact they don’t travel very much at all. That could be a factor of declining health. Sometimes retirees realize that spending time with grandchildren trumps spending time on the beach. Others travel frequently and spend large amounts of their retirement income on travel. These expenses tend to be much larger during the first decade of retirement, while healthcare expenses ramp up in later years. This fact helps to balance your expenses through your retirement.
Inflation: This is another large (or small) issue depending on many factors and is impossible to call 25-30 years in advance. Instead, we estimate.
With spending difficult to predict and factors like investment returns, inflation, and healthcare expenses next to impossible to estimate, the best plans in the world are not blueprints that will lay out the future precisely. Rather, a good plan is more of a rough draft, where you change the plans and make adjustments as needed. It makes no sense to lock into a static plan that has investment returns pegged at 7% and find 10 years later that the best you can get is 2%. (Many who retired 10 years ago are now precisely in that situation.) If you had $500,000, a difference of five percentage points’ return could be huge over a decade.
By all means get the graphs and bar charts and use them as a starting point. When inflation, spending, and investment returns become known after a year or two, make slow adjustments to the plan and keep adjusting.
You should be invested reasonably conservatively at retirement, so you shouldn’t lose 25% or more into retirement. If this happens, you have likely invested too aggressively. I have seen many seniors with their nest-egg allocated 95%-100% equity! Anything over 70% equity heading into retirement is dangerous, if you plan to retire without undue stress.
Hold some bonds, mortgages, and other fixed investments that will generate income regardless of how the markets are performing. A big mistake earlier in life can be rectified by working harder or longer. When retired, those options no longer exist, so don’t be too aggressive with your investments. That is worse than being too safe (e.g., everything in GICs).
Don’t redeem too aggressively early into retirement based on estimated returns. Withdraw monthly amounts, not irregular lump sums. The monthly income emulates a paycheque. Lump-sum redemptions can lead to unsustainable withdrawals, which deplete your principal too quickly.
In conclusion, have a plan that adapts to change. Don’t copy what other people are doing. This is a highly personalized process, because of differences in age, health, spending requirements, investment choices, tax issues, comfort levels with various investments, and many other factors.
Bruce Loeppky is a financial advisor based in Surrey, B.C., and a regular contributor to the Fund Library. He can be reached at email@example.com.
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The foregoing is for general information purposes only and is the opinion of the writer. No guarantee of performance is made or implied. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice. However, please call the author to discuss your particular circumstances.