How much money will I really need?
Let’s say you’re 55 years of age and you’re looking forward to retiring in several years. Can you give up the job and enjoy the retirement of your dreams without fear that you’ll outlive your money? How much money will you need to make this happen?
As my clients’ age, this is a question I get often. We all want to enjoy a comfortable, worry-free retirement. You’ve earned it but will your money survive what could be 30 years or more of permanent unemployment?
One of my clients, “Ed,” told me about his friend who had retired a few years ago. He thought he had sufficient funds but then came the 2008 market crash, and his savings took a 20-per-cent hit. He was considering returning to part-time work for a few years. Ed’s friend had an aggressive portfolio that might have been suitable if he were 10 years younger, but not for a retired person.
Ed’s friend failed to consider what we call the retirement risk zone. This is roughly the five years immediately before and after retirement – the time when your retirement savings are most vulnerable to market downturns. Put another way, money that’s needed for income should not be invested into anything that might go down at a time when the funds are needed.
Related article: Retirees need to be more conservative with their portfolio
Author Todd Tresidder talks about this in his fine book How Much Money Do I Need to Retire? It’s a book that Forbes calls, “This book is the best I’ve seen on how to navigate the retirement savings question.”
Tresidder says that a portfolio built on average returns “is deceptively dangerous.” For example, if you assume an average investment return of, say, seven percent, you may feel that you can safely withdraw seven percent; no so.
The problem is that seven percent is the average but it will include some negative returns. What if you’re hit with a 20-per-cent drop in the first year of retirement?
Related article: Variable returns can work against you in retirement
“This,” Tresidder writes, “is a real-world retirement problem that every retiree faces….(and) why the order of returns is so terribly important and why volatility matters. A series of losses early on combined with spending can devastate a retiree’s financial future.”
Ed is several years younger than his friend and planned to work another 10 years so he’s not yet at the same place. What Ed’s friend should have done is to create different buckets of money for different timelines.
Related article: Creating income with buckets of money
As my clients near retirement we set up three money baskets: generally, basket A for money needed in three years or less, basket B for funds needed in three to six years and basket C for long-term money. Each basket is invested appropriately for its timeline.
Basket A money, for example, could be placed into a high-interest savings account, which is protected from market volatility. The medium- and long-term baskets are invested for growth. If markets are lousy then the retiree always has three years of income to draw on as markets recover.
Tresidder’s book also discusses building what he calls a confidence interval into your retirement plan. “To build a confidence interval,” the author writes, “just vary your assumptions by raising inflation, lowering your pension payments and decreasing your investment returns.”
When you retire you definitely don’t want to be forced back to work because things didn’t turn out as expected. For example, what happens if you project investment returns of six percent, but markets don’t co-operate and you get only five percent?
You can protect yourself by using conservative variables in your plan. Essentially, this is under-promising and over-performing. This should ensure that whatever happens your retirement should be secure.
There are many online tools that you can use to calculate your retirement savings needs. Be careful if you use one of those. Even small errors can throw your numbers way out of whack.
As Tresidder writes, “garbage in equals garbage out.”
Comments
I think the only rational assumptions are a 1% or less return and at least 3% inflation. Plan to spend down your capital and be prepared to live on less.
How much money will I really need?
I’ve been fully retired since about 2007, semi-retired from 2001 when I didn’t have enough capital to see me through until early CPP.
The article touches on what I consider important: What will be my monthly cash requirement when I retire? For food & lodging, hobbies & activities, to splurge or donate. CPP & OAS are excluded here because they are buffers for the unanticipated.
The question becomes: What return on my retirement capital do I need to provide that monthly cash. Since most Canadians are low on retirement capital because they simply cannot generate the disposable income to save what many bank retirement calculators compute, everyone’s discouraged.
The amount of cash depends on the size of the retirement capital, inflation, bank interest rates, on lifestyle, consumer debt, other debt, dependents, health, sales tax changes, etc.
Savings accounts and government savings bonds of any stripe will always fall short – unless you can turn the clock back to 1981.
There are two sides to the RISK coin:
1. the risk that you will run out of cash – guaranteed when being too conservative in a low return pseudo safe portfolio.
2. the risk that your higher return portfolio will fluctuate negatively and your retirement capital will drop, but you likely have more monthly cash.
My portfolio is very aggressive, to generate the monthly cash I want. This year, 2015, my portfolio has dropped in value, but my monthly income has dropped only 5% or so. For instance, I’ve deposited $36,500 in my TfiA since 2009 but it is currently paying me $470 in cash every month (that I will reinvest next year). I don’t think it will go down further. $470/$36500=15.4% What is my TFiA worth? Not really relevant.
But let’s say the TFiA income goes down to $350; that’s still 11.5% $250? 8.2% And these changes are temporary. Do I have to adapt? Of course. But I still have way more disposable monthly cash than I need. And I still have way much morest(☺) disposable monthly cash than a conservative investment would produce.
And should I die tomorrow, my heirs will just get less. It won’t affect me one iota.
Where does the additional monthly cash come from in a conservative portfolio? Reduce the capital, which will reduce the already reduced pithy income.
Let’s not forget my reduced CPP & OAS. These are buffers in my planning; they’re not included in any budgeting.
Then there’s income tax. Many are paying an effective rate of 15, 20, 25 or 30% on their total salary income. In 2014, I paid just under 3% (including some RRSP withdrawals – I’m liquidating) because my income is tax-advantaged. I never invest in interest income of any sort in my taxable account.
So how much more disposable cash do you gain if your tax rate on your 2014 taxable income falls to 3%? Taxable income is line 260 on your T1, line 435 is the tax assessed.
Though one never invests only because of income tax considerations, income tax is an important expense on salaries and interest income.