Congratulations. You’ve laboured for decades so that you can enjoy a comfortable retirement. Or, maybe you’re retiring in a few years and are looking forward to reaping the rewards of your hard work.
Either way, you have some mighty important decisions to make – such as what investments to own, how to manage them tax efficiently and how to manage the biggest risks facing retirees. Those decisions could either secure the retirement of your dreams or put your comfortable, worry free retirement in jeopardy.
In his book, R.I.G.H.T. Answers – The Answers to 260 of Your Retirement Questions, financial educator Sam Albanese covers topics of importance for current retirees and those who aspire to join them. Want to know what retirement income you’ll get from government sources and how and when to apply? What about employer pension plans? How much will you need to save to require? It’s all here.
One of the most important issues the book addresses is a safe investment withdrawal rate so that you don’t outlive your money. “The magic number for the safe withdrawal rate is the subject of a great deal of debate,” writes Albanese, who teaches personal finance at Seneca College in Toronto.
Some pundits use a withdrawal rate as high as six per cent, a return that a medium-risk investment portfolio should generate. The problem is that many retirees have only GICs (guaranteed investment certificates) paying a third of that. Albanese touts a withdrawal rate of four per cent, but even that may be too high if you have only GICs.
What if you invest into mutual funds and you experience negative returns shortly before or after retirement? Your portfolio may never recover given that you’re withdrawing money. “There is one important factor to bear in mind when investing during retirement,” Albanese writes. “It becomes very difficult to make up for losses.”
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Your income in retirement is likely much less than when you were working, you’re probably not investing new money and time is no longer on your side. If your investments drop 10 per cent in the first two years of your retirement, you need to get 11.1 per cent to break even after three years.
Therefore, Albanese says that the years immediately before and after your retirement date are essential to the sustainability of your retirement. Moshe Milevsky, an authority on retirement income from York University, calls the five years immediately before and after retirement “the retirement risk zone.” Your investment returns during these years can make or break your retirement.
How then should retirees invest? Many people feel that once they retire they must put their money into GICs or some similar “risk-free” investment. GICs are not risk free! In fact, GICs can be risker than, for example, a conservative investment portfolio.
Current GIC rates are around 2 per cent to 2.5 per cent. If you get that return and withdraw four per cent, your money will run out.
Having short-term money in GICs can be appropriate, but it can be a severe mistake to put all of your savings into products that often generate a negative rate of return after inflation and taxes.
I often advise my clients to allocate their money to three different “baskets.” Each money basket is designed for different timelines and different purposes.
Basket 1 is for money you may need in the next three years or so. For this you might use a high-interest savings account. Basket 2 is money you expect to need over three to six years (perhaps balanced mutual funds). Basket 3 is for longer-term money that can be invested for growth.
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The financial and investment decisions when you are in or nearing retirement can be among the most important you’ll ever make. Good decisions can secure your dream retirement. Poor ones can turn a good retirement pretty ugly pretty quickly.