A Different Perspective on Saving for Retirement

John and Janet, both aged 40, are married with twin 8-year olds. They have a low six-figure family income and a $220,000 mortgage. They just manage to make ends meet financially, but are now looking ahead to financing two university educations in ten years plus retirement in twenty years. John is self-employed and Janet is an employee, and neither has a work-related pension plan.

They recently decided that turning forty officially rang the bell to start saving for later years, even if it meant cutting back on something today. So, they started a monthly saving program to put aside $10,000 per year in RRSPs, which was not easy.

So, now they have joined the ranks of “investors” at an unpleasant juncture in the markets. They visited with us to discuss investment strategies. Given the extreme hardship wrought by equity markets, John half-seriously suggested putting the money in a sock every month until they retire.

Twenty years of saving $10,000 would create $200,000 of capital at age sixty. If the money sat in the sock, that’s what would be there then. Assuming no inflation, that $200,000, representing twenty years of hard saving, would finance eight years of retirement (assuming $50,000 per year of spending, half of which covered by their OAS and CPP). More realistically, a modest 2% inflation over twenty years would cause their capital to deplete in under six years. Think about this: half an adult life-time of fairly significant savings would finance six years of retirement!

Now, we see the importance, and power, of investing and compounding. An appropriate investment strategy for them may, perhaps, yield a realistic 7% return over the next twenty years. After twenty years, the income will grow to approximately $200,000, thus doubling the wealth upon retirement, and tripling the number of retirement years financed.

Of course, one can argue about the appropriate assumption of long term yields (almost always, by the way, coloured by whatever the present is yielding!) but the indelible lessons are:

  • First, putting aside capital for later years is very important
  • Second, the average person cannot save enough pure capital to fund retirement
  • Third, the earlier the better.

What, me worry?

A recent Ipsos Reid international survey reported that 59% of Canadians are concerned about their retirement prospects. The report went on further to say that anxiety can be reduced by using retirement planning tools. Pundits are saying that tomorrow’s retirees will be able to work longer, due to greater longevity and less physically-straining vocations (ie more knowledge-based careers). Another international study, by the Centre for Strategic & International Studies, cites the downstream impact of demographics. The relative growth in the near future of the aged population “poses a significant threat to global prosperity”.

The current bloodbath in world equity markets is also having an effect on expectations. A U.S. study reports that the average expected retirement age has increased by almost a year in the last four years. Twenty percent of those surveyed have pushed out their retirement expectations, on average, by over four years.

We have been preparing long term retirement forecasts for some clients in the last three months. One of the parameters in that process is an assumption about long term rates of return for various classes of investments: real estate, stocks and bonds. Given the climate of the times, we have been adding a second forecast to our report which downgrades these supposed returns by 2%. In all cases, the result has been that the life duration of the capital has declined by approximately twelve years or, in plainer language, people’s money ran out twelve years sooner.

The popular press is full of articles on this subject. To some extent, sensationalism always sells newspapers across the ages.

We believe that the following can be said:

  • It is human nature to focus on the recent to forecast the morrow. This happens in both directions, when the recent news is bad and when the recent news is good. Prudence requests that longer term perspective is kept in mind.
  • A balanced portfolio rides across the middle of the waves, neither soaring on the crest nor tanking in the trough.
  • There is still a fair degree of latitude in what constitutes a “balanced” portfolio, perhaps anywhere from 30-70% in equities. Find the balance within the broad range of “balanced” that YOU require. This is best ascertained through quantitative analysis rather than checking your heartbeat when there is a bear market.
  • Revisit your decision periodically over your life time with the purpose of re-setting your own personal balance mix. One mix does not fit for a life time.
  • Once you set your mix, stand fast with it through thick and thin. This may require periodic re-balancing in response to the market-place, in both bull and bear markets. A recent study by Schlindwein Assoc LLC suggests that investors and their managers do not stick to the discipline. Their actual allocations vary significantly from their plans, in both directions, ie many were too conservative and equally many were too aggressive.
  • Some press coverage suggests that the Boomers will experience and cause a declining stock market because they will be selling of their equities en masse to fund their retirements. This should not be so. RRIF rules only require 7-10% to be withdrawn annually. With proper investment planning, the fixed income component of retirees’ portfolios should have sufficient income plus maturing bonds to finance most of their draws’ requirements for many years. The re-balancing process likely will call for selling off equities at some point, but this can be managed to some extent to wait out bear markets.

Financial Planning Survey

We undertook a survey in 2002 of clients who have engaged us to undertake formal financial planning and a retirement forecast. Here’s what they said:

  • 100% said they would recommend the process
  • 85% said the plan should be updated periodically, somewhere between 2-5 years
  • 67% said the value of the plan was good or excellent relative to the cost
  • 100% valued the written report as good or excellent

Benefits of the process:

  • 85% said it resulted in a concrete, executable plan
  • 100% said it assisted greatly in clarifying a retirement date
  • 100% said it assisted greatly in establishing strategy for investment portfolios
  • 73% said it clarified the financing of future major expenditures
  • 67% said it clarified the need for future savings
  • 67% said it clarified future estate values for heirs