If you’ve postponed your retirement in the wake of the recent stock market plunge, you should be asking yourself why.
If it’s because your savings have declined and you’re afraid you won’t have enough, or if it’s because you’re spooked by volatile markets, then you need to take another look at your retirement plan.
Here’s the thing: A well-constructed retirement plan accounts for unfavourable events. It should assume that things are going to go sideways sometimes, whether that’s due to higher inflation, changes in interest rates or stock market volatility.
Some parts of your retirement plan are reliable, such as Canada Pension Plan, Old Age Security and a defined benefit pension plan. These sources of income provide a stable base, since they are indexed to inflation and are not impacted by stock-market gyrations. (Not all pension payments are indexed to inflation, and some are only partially indexed.)
It’s the other income – money taken from your investment accounts – that is vulnerable. The primary risk that retirement planning addresses is the fear of running out of money before you die.
To make sure that doesn’t happen, financial planners create forecasts to determine how much you need. They look at how much you can take out of your savings each year until a specific age, making assumptions about inflation and how much your investments will earn.
For example, imagine you have $800,000 in savings the year you retire, and that you can earn 6 per cent per year by investing your savings with a 2-per-cent inflation rate. A forecast might show that you can safely withdraw $43,000 a year, rising with inflation for 30 years.
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It looks great on paper, but the world doesn’t work like that.
If you retire in a year when the stock market doesn’t give you your 6-per-cent return but instead minus 20 per cent, you face what financial planners call a “sequence of returns” risk. In short, it means that a poor stock market return early in retirement has depleted your savings faster than your plan showed and that you risk running out of money.
And if this is what you’re nervous about, you shouldn’t be.
This sequence of returns risk is something that can and should be addressed by your financial planner or adviser. It’s a well-known – and hotly debated – topic in the field, and there are solutions that can help mitigate the risk. Not only do these techniques help protect your savings, but they also allow you to stop obsessing about the stock market.
One way to address the risk is to increase your exposure to bonds and GICs closer to retirement. This means you will have a portion of your portfolio that doesn’t fluctuate very much, and you can draw from these investments in a really bad year for stocks.
A second approach is to keep one or two years’ worth of your annual withdrawals in cash, so that you don’t have to sell anything if the markets tumble. This is my preferred approach because it allows you to stay invested in stocks to get long-term growth but not worry about this year’s roller coaster ride.
Another is to adjust the amount you withdraw from your accounts each year instead of taking the same amount regardless of how markets are performing. Take more in good years and less in bad ones.
Which of these is right for you depends on another factor: your ability to stick with a plan even when the headlines are scary. If you have a portfolio heavily invested in stocks – a strategy that can be appropriate even for retirees – you need to have the fortitude to stay invested, no matter what.
If you panic and sell, or if you worry about your investments constantly, then you need to take a more conservative approach, such as owning more bonds and GICs.
A good investment plan finds the balance between having enough stock exposure to make your money last while keeping your nerves in check. If you are considering delaying your retirement because of the stock market, then you probably don’t have this balance right.
Anita Bruinsma is a Toronto-based financial planner and investment coach. You can find her at Clarity Personal Finance.
