Now, while this statement may be seem obvious to some, it’s one I feel needs to be made.
Your retirement will last longer than this market correction — much, much longer.
It might be hard to think about this right now, given how the markets have dropped and all, but it is important to keep perspective in these times.
Its important to understand that investments will rebound and continue to grow during retirement – which for most will be 30 years or more…
You will pull through this market adjustment!
Trust me – I’ve been through 5 of them in my 22 years in the financial services industry.
The real risks in retirement and to retirement income are: longevity (outliving your money), inflation, withdrawal rates, asset allocation and health care.
How many of you are looking through the current volatility to the important long-term issues of planning for income in retirement?
Now, what’s your plan for tackling each of these risks?
Longevity
The simple fact is that retirements are getting longer. In some cases, they can be as long as your working life — 30 years or more for many people. But as retirements increase, so do the risks of outliving your capital. The longevity of Canadians is not going to reverse just because markets are volatile and the economic outlook is uncertain.
Even if some of you choose to retire later than had originally planned, the length of your retirement is likely to be just as long as if you hadn’t delayed.
Inflation
Canada will likely experience an average annual inflation rate of at least 2% per year going forward.
How will this affect retirement income plans! Well, with inflation at 2% annually over a 25-year period this reduces the purchasing power of your retirement income to approximately 60% of its original value!
Interest rates on short-term government securities and longer-term government bonds may rise a little over the next few years as investors move away from the safety of government securities and back to other types of securities in search of higher returns, but interest rates on government securities are not likely to rise enough to provide the protection against inflation that most retirees are looking for.
Therefore, you will still need to look beyond the current urge to be in “cash” and consider the role equities should play in their retirement portfolio.
Withdrawal rates
There will always be discussions about appropriate annual inflation-adjusted withdrawal rates from your retirement portfolios. Some individuals will be thinking of raising their annual withdrawal rates in order to maintain specific income streams from portfolios that are valued less than they were a few months ago.
However, research has demonstrated time and again that for people in their mid-sixties, an inflation-adjusted annual withdrawal rate of 4% is the ideal rate to extend portfolio life to its maximum.
This raises the very basic question of how to keep your withdrawal rates low when investment portfolios are also down. There aren’t any easy answers.
However, one strategy is to always have 2-3 years of basic “living expenses” set aside as “cash”. Then “harvest” profits from portfolios to add to this “cash cushion” when markets are good and draw on the cash when markets are down.
Asset allocation
This brings us to the fourth risk to retirement income which is asset allocation. There are some basic rules for asset allocation that apply to almost everyone — equities, fixed income and cash.
All research shows that having equities in a portfolio is likely to result in the longest portfolio life.
The mistakes made most often in asset allocation are having too much of one asset category.
Having to much in “cash” is just as bad as having to much in fixed income or equities…
Health care
The fifth risk to retirement income is health-related expenses. Not only out-of-pocket health costs but also age-related costs such as the help that may be required for housing and daily care in the later years of retirement.
Like longevity, the need to prepare for health-related expenses doesn’t change just because markets are volatile.
However, what volatile markets may accomplish is to make individuals give serious thought to these costs, and to their choices now and as they age.
Another specific planning area to consider is to build a separate ‘health-care’ fund. In addition to its practical usefulness, a health-care fund will increase individuals’ peace of mind, because they are actually addressing a potential risk to retirement income.
So, while none of us can control the markets there is a great deal we can control and this is the time to do just that.
Knowing all sources of retirement income and their characteristics, facing various economic and market prospects head on and preparing to be flexible enough to react to events as they unfold are likely to improve your retirement prospects in a big way.
So, keep these things in mind when you contribute to your RRSPs this year!
You are going to aren’t you?
Because, as you will be spending the rest of your life in your future: it would be best to do everything possible now to make it a future worth living in! Right?!
