Canadians are living longer these days. Because of this, it becomes even more important to be financially prepared. I can’t tell you how often it is that when I sit with a client who is retired or who is preparing to retire that the fear of outliving their money comes up. The fear is a real one, but it doesn’t hurt to know a little bit about the risk of longevity to perhaps understand it better.
Today we are going talk about the critical 5-10 before retirement and the equally critical 5-10 after retirement. These years are known as the retirement risk zone.
Let’s look at some numbers:
Longevity for 65 year old Canadians
- A 65-year-old woman has a 50% chance of living to age 86 and a 25% chance of reaching age 92.
- A 65-year-old man has a 50% chance of living to age 83 and a 25% chance of reaching age 89.
- For a couple both aged 65, there’s a 50% chance that at least one spouse will reach age 90.
Source: Canadian Institute of Actuaries
One of the less commonly discussed risks of retirement is the risk of having too much market risk in your portfolio at a time when you need income. Here is an opportunity to create and build awareness for something called the retirement risk zone.
Retirement Risk Zone
The 5 to 10 years before and after the onset of retirement or the time when cash-flow begins represent a very fragile and critical period in the investor’s financial lifecycle. It is called the Retirement Risk Zone. When planning for retirement, retirees should consider a review of their portfolios and see how much exposure they have to market risk during this period when the retirement nest egg is most vulnerable to market downturns. The retirement risk zone should be important to investors and advisors alike because short term portfolio losses due to market performance during this time can have significant, long term, negative effects on the longevity of the investment portfolio.
Sequence of Returns
It is vital that investors in the retirement risk zone are aware that the sequence of returns can have a dramatic effect on the longevity of an investor’s portfolio when the emphasis switches from accumulation to spending. Put another way, investors and advisors should be mindful that the order of the rates of return that an investment earns over a period of time may not matter when saving for retirement. Yet they get surprised all the time.
The order of the rates of return matters a great deal when the investor is spending their accumulated money during retirement and it can be a much bigger surprise.
Most investors these days are exposed to the markets, including those that are in the retirement risk zone. Most financial and retirement planning is done using average return assumptions. No investment based product package returns an assumed rate of return consistently for decades. The sequence of returns may not matter during an accumulation period; it may not impact average rates of return.
Average returns can be misleading particularly during income generation. Negative returns early in the withdrawal cycle magnify the challenge in returning to asset levels capable of generating sustainable income. Volatility may not be a big issue during the accumulation years; in fact, it can even be quite beneficial when looking at dollar cost averaging tactics. At the other end however, volatility can be very troublesome to a portfolio’s size and its ability to generate sustainable income for life during retirement years, particularly low or negative returns in the retirement risk zone.
An investor in the Accumulation Phase, that period of time when their primary focus is on building their long-term investment nest egg, has a longer time-period to recoup losses, earn income and invest additional monies. Someone in the Retirement Risk Zone may not have the luxury of time to sit on an investment and wait for positive rates of return to make up for investment losses.
Any new monies invested just before retirement may not be left to grow long enough and potentially reap the benefits of longer term, positive investment returns. Furthermore, an investor in the Retirement Risk Zone may be withdrawing income and thus depleting assets faster. A negative sequence of returns has a greater and long-term effect during the Retirement Risk Zone than in the Accumulation Phase.
So, what is one safeguarding measure? Low volatility of an investment that does have respectable rates of return in line with the particular investor’s overall plans, is quite an attractive alternative for helping to make retirement income plans work. This is in addition to having some cash on hand or very conservatively invested savings that can be used for cash flow and to support lifestyle when markets are underperforming.
Clients (or readers) that have been with me for any period know that I am a strong proponent of Guaranteed Investment Funds because of the guarantees on their investments. That means we remove the down risk and are still able to participate when the market goes. There is no perfect investment, but when you are in the Retirement Risk Zone, Guaranteed Investment Funds come as close to perfect as you will find. For a refresher, read my articles here: KBH GUARANTEED INVESTMENT FUND ARTICLES
If you would like to discuss your portfolio or how segregated funds can help you, feel free to reach out and chat with me here: FREE 15 MINUTES WITH KBH
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THIS ARTICLE IS PROVIDED AS A GENERAL SOURCE OF INFORMATION ONLY AND SHOULD NOT BE CONSIDERED TO BE PERSONAL INVESTMENT OR LEGAL ADVICE. READERS SHOULD CONSULT WITH THEIR FINANCIAL OR LEGAL ADVISOR TO ENSURE IT IS SUITABLE FOR THEIR CIRCUMSTANCES.