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 per cent, you may feel that you can safely withdraw seven per cent; no so.
The problem is that seven per cent 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 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 our as expected. For example, what happens if you project investment returns of six per cent, but markets don’t co-operate and you get only five per cent?
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.”