Living To 100: Can You Afford It
You could live to be 100 … will your savings last as long?
The latest figures from Statistics Canada show that more Canadians are reaching the 100-year milestone than ever before. It also reports those of us who reach age 65 can expect to live on average another 20 years in retirement. That's good news indeed, but it means after having spent roughly 40 years in the workforce, pension plan members now face the challenge of providing an income for an additional 50 per cent of that time in retirement.
This can create significant pressures for plan members as the scale of the funds required to retire comfortably continues to increase. Unfortunately, many are totally unprepared for the significant drop in income that is likely to occur and may struggle financially once they reach retirement age.
As economic growth slows in Canada, many people, especially those close to retirement, are starting to feel uncertain about their future. Many haven't even calculated whether they've saved enough to support themselves through their later years, making the situation even more difficult. Old age is inevitable. However, having the necessary savings on which to retire comfortably is not. In fact, some Canadians may need to work beyond normal retirement age to ensure a comfortable standard of living.
With bond yields at record lows and slow economic growth expected to temper Canada's stock market gains, pension plan members are finding fewer opportunities to grow their retirement savings. This situation is being made worse by fiscal habits that make it more difficult for them to save for the future.
Because of increased fiscal and investment risks, it has become increasingly important for pension members to plan more strategically and understand the likely drop in income they could face in retirement. The key to surviving any downside scenario is to plan for it, to determine in advance what you can do today to minimize the impact, and what steps you are willing to take to survive should you find yourself with inadequate resources to live on.
Planning is essential. Any decision about retirement is likely to be an important one and, therefore, members of pension plans need to be confident that their retirement arrangements can provide for them and their family's financial security well into the future. Making the right choices is vital as the value of members' benefits at retirement age will depend on contributions paid, the length of time they have been invested, and on investment returns achieved.
Remember unless members are reasonably close to retirement age, they should view their retirement plan as a long-term investment. The road to retirement (the number of years members have to save and invest) will typically fall between 20 to 30 years, sometimes more.
For members with a long time horizon (20 to 30 years), short-term market fluctuations are less important. There is generally sufficient time for market values to recover and achieve their long-term expected returns. For members with a shorter time horizon, the effect of swings in the stock market is potentially more problematic as there may not be sufficient time for the value of their investments to recover before retirement age. Therefore, for members who are close to retirement, the less volatile investment categories such as fixed interest and cash may be more suitable as they can protect against potential short-term losses in the equity markets.
Generally, investments can be categorized as either defensive or growth-oriented. Defensive investments – such as cash and bonds – protect against the chance of negative returns, but generally produce lower, though more stable, short-term returns. Growth investments such as equities have historically experienced short-term volatility (sudden ups and downs), but greater long-term returns. Therefore resulting investment strategy should be one that minimizes the ups and downs consistently while giving members the required level of total returns to meet their financial goals.
Every investment carries risk. To determine how much of a trade-off a pension plan member is willing to make, they should consider how much risk they are comfortable with. The direct relationship between risk and return also means that the higher the returns they aim for, the greater the potential volatility of the investment and the greater their tolerance of risk has to be. The opposite is also true. If members only aim for low returns, their chosen fund is likely to be less volatile and their risk tolerance does not have to be as high.
For members, finding their 'risk comfort zone' is important as it is their tolerance to risk that determines how much they may allocate to each investment type. Diversifying retirement investment across a number of investment types can help spread risk involved with investing.
However retirement planning rarely involves one-off decisions and tolerance of risk may change over time. Members may find that, as they gain more knowledge and experience with investing, they become more comfortable with a higher level of risk. However, as retirement approaches and investors are forced to live off their assets, capital preservation becomes more important, For this reason retirees may find their risk tolerance declines significantly. So it is also important that plan members are prompted to review their risk tolerance as regularly as they review their investments.
Financial Shock Wave
At present, only one in four Canadians have a RRSP despite that fact that the retirement period is longer than ever before. Many Canadians are simply unaware of the pending financial shock wave that awaits them at retirement. Having a strategic approach to retirement planning from an early working age should help to create a more sustainable financial future for the ever increasing numbers joining the golden generation.
The important thing for members of pension plans is to start planning early, take advantage of their regular income while they work, maximize their tax savings, and build a portfolio that best suits their own retirement needs. Then, if they are lucky enough to reach the century mark, their retirement finances won't fall short.
Bob Stammers (CFA) is director of investor education at CFA Institute.