You may think you’re ready for retirement. You’ve saved, you’ve invested, you have a nest egg, and now all there’s left to do is give away your work clothes, right? Not quite.
“Even retirees who are seasoned investors will tell you that transitioning from accumulating to spending from their portfolios is a challenge. Devising an asset allocation plan that balances safety and liquidity with long-term growth is no mean feat, either, especially given today's high(ish) equity valuations and painfully low yields on bonds and cash. There are also psychological hurdles to jump over: After years of saving, transitioning into drawdown mode can feel a little bit scary,” points out Morningstar’s director of personal finance Christine Benz.
Plus, retirees are living longer. The World Economic Forum established that someone born in 1947 - the second year of the baby-boomer cohort - had a life expectancy of 85 years, reports Philip Petursson, chief investment strategist and head of capital markets research at Manulife Investment Management. But someone born in 1977 - the last Xers – would live to 94 years.
What If You Live to 150?
That points to the most important blind spot and largest risk related to retiring today: the longevity risk. As Morningstar Imvestment Management’s head of retirement research David Blanchett points out in his report ‘The Retirement Mirage’, “Choosing when to retire is one of the single most important financial decisions we make in our lives. Knowing when we plan to retire helps determine how much money we need to save and our standard of living in the meantime. Unfortunately, our retirement plans are often wrong. People retire earlier than expected for a variety of reasons—including health issues and job changes—but the impact can be severe.”
This is especially true if one retires earlier, and lives longer. “Longevity risk is largely underappreciated,” comments Petursson. He adds that someone born in 1947 needed roughly 50% more capital than a person born in the previous generation, and for someone born in 1977, the extra capital needed is about 30%.
With the longevity risk comes a shortfall risk: the possibility of outliving one’s savings. In fact, to cover for the longevity and shortfall risks, and considering that 94 years is an average life expectancy, one should develop one’s retirement plan with the expectation of living to 100. “That’s what I calculate for,” says Michelle Munro, tax and retirement expert at Fidelity Investments.
A recent survey of 1,929 respondents by Fidelity (Retirement 20/20) shows that only 17% plan that far out. The largest cohort (53%) plans between 85 and 95 years of age, and 28% plans between 70 and 80 years of age.
“Our findings suggest that given this uncertainty around retirement age, some investors may need double their current savings to achieve their retirement targets. A person’s retirement age is simply too unpredictable, and we must plan accordingly to help avoid negative surprises,” Blanchett says.
The Health Curveball
The other major blind spot of retirees is health care and assisted-living costs.
“You often read about all the money you'll save when you're no longer working--on dry-cleaning, commuting, lunches out, and not having to save so much for retirement anymore. Given that cavalcade of savings, it's not surprising that so many retirees fall back on the conventional wisdom that they'll only need to replace 80% of their income during their working years when they actually retire. In reality, that 80% rule is at best a rule of thumb; some retirees actually spend more than they did while they were working, while others spend much less. (Healthcare costs are one of the biggest wild cards)” warns Benz.
One area where expenses can definitely explode: intensive care for the last period of one’s life, which could range from a few months, to a few years. “That is a huge expenditure,” highlights Munro, adding that the last third part of one’s life will probably not be a beach party.”
From 1994 to 2015, life expectancy at birth of males rose from 75 to 80 years, indicates a 2018 StatCan report, but health-adjusted life expectancy (HALE) went from 65 to 69 years. For women, life expectancy at birth increased from 81 to 84, years, and HALE, from 68 to 70.5 years. Males have to plan with the potential of about 11 years of health complaints, females, with 12 years. Among the six health attributes of mobility, pain, sensory, dexterity, emotion and cognition, mobility stands out as the more important source of diminished health for males, whilst for females, it is mobility and pain.
Asset Allocation ‘Rules’
Many people talk about a simple rule of thumb: 100 minus Age = Equity. Put another way, if you are 70, 70% of your portfolio should be in bonds.
But that is not practical anymore. “Historically low interest rates cause revenue on ‘safe’ investment grade bonds to be insufficient to generate revenue for many retirees. Today, our capital in retirement still needs to generate a return, yet it’s harder and harder to generate a return with interest rates. The challenge for retirees is to find asset categories that will still generate return while not inordinately increasing risk,” says Petursson.
To mitigate that risk, it appears that coming retirees plan to continue working beyond retirement. Blanchett calls delaying retirement a ‘silver bullet’. “You've got one more year to save, one more year for your assets to grow, one more year for your CPP to grow, one less year to plan for in retirement. So, it's really, really good,” he says.
Planning Blind Spot
The Fidelity survey clearly points to a potential area of hardship: neglecting to devise a retirement plan. Asked about their level of financial preparedness for retirement, 94% of retirees who have a plan claim that they feel prepared, but only 72% of those without a plan claim as much. Among pre-retirees, the difference is sharper: 78% of those with a plan say that they feel prepared, but only 44% without a plan say so.
Munro insists that such planning should preferably be carried out with a professional. But don’t plan financially only. Key areas of retirement to consider are one’s social and emotional health. It is now an established fact that people who have strong networks of relatives and friends age better. Let’s drink to that! But not too much...
