Over the years we have helped many individuals at all stages of life. Here are the top 10 mistakes we have seen when it comes to retirement — and our advice on how to avoid them.
1. Underestimating the impact of inflation
Inflation impacts your purchasing power, and it is critical that retirees do not underestimate its impact.
The Bank of Canada aims to keep inflation at two per cent, within a control range of one per cent on either side (i.e., as low as one per cent and as high as three per cent). However, in the past year Canadians have been experiencing a period of higher-than-normal inflation with it reaching a 39-year high of 8.1 per cent.
So, what can you do to maintain your purchasing power?
While investing in the stock market inherently has its own risks, there are many factors to manage these risks with your Portfolio Manager by determining an appropriate asset mix, an optimal number of holdings and position size, ensuring appropriate diversification to manage concentration risk, taking a disciplined approach to rebalancing, and managing your time horizon for investing.
2. Understating how long individuals will live
The average lifespan in Canada has been gradually increasing over time. In the past 60 years, the average lifespan has increased by approximately 11 years, and retirees find themselves spending almost as much time in retirement as they spent working.
When we begin working with new clients, we ask them for family tree information since it enables us to have a discussion about genetics and life expectancy, which we factor into the Total Wealth Plan.
Medical advancements are also helping individuals live longer than before. As a result of medical advancements and genetics, if you have one, or both, parents who lived well into their 90s, or are alive and in their 90s, then it’s prudent to plan that you too will live into, or past, your 90s.
In some cases, one parent may have died prematurely, when another lived a long and healthy life. In these instances, it is still prudent to plan to live into, or past, your 90s.
3. Overestimating investment returns and income
When we do financial plans, we always assume a four per cent rate of return to be conservative.
Often, we will run a couple of scenarios to see what it would look like if the inflation-adjusted, after-tax return is two per cent, and another example where it is six per cent. While it may not sound like a big difference, over the span of retirement it can have a big impact.
To illustrate, say you lived 25 years in retirement. You retired with $1 million in the bank and took $50,000 per year for cash flow purposes. Here’s how much you would have after 25 years, assuming you continued to take $50,000 per year, based on these different return outcomes:
As you can see, taking $50,000 per year and earning an after-tax, inflation adjusted two per cent rate of return cuts it very close. If the individual lives longer than the anticipated 25 years in retirement and does not earn more, they run the risk of depleting their capital.
We always recommend planning for the most likely scenario; however, it’s a helpful tool to look at different scenarios to have the full picture. This exercise may show the client they need to update their annual withdrawal amount, or adjust their investment and risk objectives, and asset allocation accordingly to achieve the desired results.
4. Being too conservative with investments
Risk and reward are a tradeoff, and risk isn’t necessarily a bad word. There are many ways to manage risk through asset mix, diversification, position size, rebalancing, and time horizon.
In my opinion, being too conservative with your investments is a risk in and of itself. Two common characteristics we see with our clients that have accumulated wealth is the ability to both assume risk, and the ability to stay the course during periods of volatility.
If all you ever do is store your cash under the mattress, or purchase Guaranteed Investment Certificates (GICs), you are sitting back and doing nothing while watching your hard-earned savings get eroded year-after-year by inflation.
The key is to find a happy medium that you are comfortable with, and invest only in good quality, non-speculative investments.
5. Being too aggressive with investments
On the flip side to being too conservative with your investments is being too aggressive and taking unnecessary risks.
We have seen many scenarios where significant sums of money have been lost as a result of investing in speculative, high-risk holdings, or having not managed concentration risk by holding excessive position sizes.
While risk and reward are a trade-off, when it comes to your retirement savings, being too aggressive and taking too many risks is not worth it. Don’t invest in anything you don’t understand, especially if it is high-risk or speculative in nature.
6. Lack of communication about the retirement phase
When you picture your ideal retirement, what does it look like? What are you looking forward to? What aspects of retirement are concerning you?
If you have a significant other, in retirement you will be together 24 hours a day, seven days a week. There may be activities you want to do together, and some that you want to do independently.
Retirement looks different for everyone — for some it includes travel, for other it includes staying close to home spending time with friends, loved ones, and doing hobbies they enjoy, and sometimes it’s a mix of both. However, the key point is to make sure you and your partner are on the same page.
The first years of retirement are often the best health wise and energy wise. In our experience, we find that couples who have communicated and reached a consensus on what they both want to do with and get out of their retirement can ensure that their retirement goals are met. We have also found that this conversation is best not left until after retirement, but rather had several years beforehand.
As you’re completing your retirement vision, have discussions with your Portfolio Manager to map out a plan to make sure the necessary cash flows are available. It’s especially important in periods of volatility to ensure you can still meet your retirement goals without having to sell a holding at the wrong point in the equity market cycle.
7. Not mapping out cash flow needs
Holding cash in your portfolio can provide comfort in uncertain times. During downward markets, a phrase often heard is “cash is king.”
At the beginning of every client meeting, we ask what their cash flow needs are. Cash flow needs are adjusted on an ongoing basis depending on what each individual client requires. Some clients may not require any cash flow, others may require a combination of monthly and lump-sum withdrawals.
Whatever the case is, one common mistake we see is not forecasting upcoming cash flows and planning accordingly for them, and the result is often being forced to sell something at the wrong point in the market cycle or draw funds from a registered plan with tax consequences that could have been minimized.
For our clients, we use a cash wedge strategy where we set aside one to two years’ worth of cash flow needs from the investment portfolio into a cash equivalent that has no exposure to market volatility. While it may earn a small amount of interest, it will not go down in value.
For clients with significant funds in registered plans, corporate accounts, or non-registered accounts with significant capital gains, we look long-term as part of the Total Wealth Planning process to map out a strategy to access the funds while minimizing the amount of tax paid over the client’s lifetime.
8. Not starting to save early for retirement
The power of compounded growth is substantial, and the earlier you begin saving for retirement, the more compounded growth your investments will earn.
To illustrate, say at the age of 25 you begin investing $12,000 per year ($1,000 per month) and earn an average rate of return of four per cent. Forty years later, you retire at 65 with $1,185,918 and contributed $480,000 in total.
Conversely, say at the age of 45 you begin investing $24,000 per year ($2,000 per month) and earn an average rate of return of four per cent. Twenty years later, you retire at age 65 with $743,261 and contributed $480,000 in total.
Comparing these two examples, the same amount has been contributed, but the difference in starting to invest your retirement savings sooner, rather than later, is substantial: $442,658 in this case ($1,185,918 - $743,261)!
If you have put off saving for retirement, we encourage you to start today. To benefit from compounding growth, the sooner you can start, the better off you’ll be for it in the long run.
9. Not having an estate plan
Many people seem to devote more time to planning a vacation, buying a car, or even selecting a spot to eat dinner than they do to estate planning; however, having a will is arguably one of the most important things you can do for yourself and your family. Not only can a will legally protect your loved ones and assets, but it can also specify exactly how you would like your affairs handled after you have passed away.
Retirement is a perfect time to do a complete estate-planning review by looking at all relevant documents (Will, Power of Attorney, Representation Agreement) and beneficiary designations for registered accounts. If you don’t have these documents in place, or if they are out of date, then to avoid an estate headache for your loved ones, we highly recommend updating these.
10. Not having a Total Wealth Plan
Last, but not least, one of the biggest mistakes we see with retirees is not having a Total Wealth Plan in place.
Having a Total Wealth Plan, and updating it periodically, or if there is a major change in circumstances, is a helpful tool to formalize a financial roadmap for your retirement. By putting your retirement goals into a plan, you can make sure they are achieved.
If you don’t have a Total Wealth Plan in place, speak to your Portfolio Manager today to get one started.
Kevin Greenard CPA CA FMA CFP CIM is a Senior Wealth Advisor and Portfolio Manager, Wealth Management with The Greenard Group at Scotia Wealth Management in Victoria. His column appears every week at timescolonist.com. Call 250.389.2138, email firstname.lastname@example.org, or visit greenardgroup.com.