5 Reasons Your Retirement Plan May Not Succeed
It's a brand new year.
A fresh start.
While many people may be starting off the year wishing and dreaming of retirement, you'll have better results if you start the year off right by beginning with a plan.
If you'd like to retire in 2023, here are 5 potential risks which could cause your retirement to fail and tips on how to avoid these pitfalls.
#1. Longevity Risk
One of the top risks in retirement is living longer than expected and outliving your savings. This uncertainty of our lifespan and the consequences of living longer than expected is known as longevity risk. With people living longer than ever before, it's important to prepare for a long retirement and ensure that you have the financial resources to support yourself for as long as you may live.
When starting to plan for retirement, it is common to begin by looking up statistics on life expectancy. While this is a good first step, life expectancy only tells us the average age at which people die, and by definition, half of the population will live longer than average. Focusing on the average can also be misleading, as it does not take into account individual circumstances and natural variability in life expectancy. Recognize that there is a very real chance that you may live much longer than average and plan accordingly.
According to FP Canada, the governing body of the Certified Financial Planner designation, it is recommended that people should plan for a retirement that will last until there is only a 25% chance of living longer, based on statistical averages. For individuals who have already reached age 60, the 2022 planning assumptions guidelines estimate this age to be 94 for males and 96 for females.
Longevity risk is one of the toughest challenges that retirees face. The wide variability in potential lifespan is a factor that shouldn’t be underestimated. By being proactive and planning for a longer-than-average life, you can help ensure that you have the financial resources you need to sustain yourself throughout your entire retirement.
#2. Not Enough Pension Income
Another key reason that your retirement plan may not succeed is a lack of pension income. Pension income has many benefits, and even those without a traditional defined-benefit workplace pension still have options for proactively choosing their level of pension income.
One of the major benefits of pension income is the protection that it provides against longevity risk. With pension income, the payments will continue for as long as you live. If your pension income is enough to cover your essential expenses, longevity risk becomes much less of a threat.
Pension income can also provide a more consistent source of spending power that is not tied to the stock market. This can be especially important in times of market volatility, as it can help to provide a stable source of income that you can rely on to meet your expenses.
An often underrated benefit of pension income is its’ simplicity. Each month you’ll receive your payment and only have to think about how to spend it. In contrast, if you’re relying on a large investment portfolio to provide cash flow in retirement, you’ll have the ongoing requirement to manage your investments (or manage your investment manager). The larger the investment portfolio, the higher the stakes and the greater the need for ongoing financial literacy. Even if you enjoy learning about the investing process, will that still be the case in your 80s or 90s? Will your spouse be able to maintain the investments if you are no longer able to?
Those without workplace pensions should consider deferring their Canada Pension Plan (CPP) or Old Age Security (OAS) benefits to increase their pension income in retirement. Deferring these benefits can provide you with a higher monthly payout, which creates a stronger foundation to build the rest of your retirement plan.
If you would like even more pension income on top of CPP and OAS, buying an annuity can be a useful tool to further increase your dependable monthly income.
Understanding your pension options will help you to make informed decisions and create a retirement income plan which meets your needs and goals.
#3. Lack of Diversification
Diversification is frequently called the only free lunch in investing. While this basic investing principle has long been known, I still regularly see client investment portfolios with a shocking level of concentration. This comes with more risk than most people realize, especially during retirement.
Diversification is the practice of spreading your investments across a variety of asset classes, industries, and geographic regions to reduce the overall volatility of your portfolio. By diversifying, you can limit the impact of any one investment or economic event on your portfolio, which can help to smooth out returns over time.
A lack of diversification can be risky because it means that your investments are more vulnerable to market fluctuations. This is particularly important in retirement if you will be relying on your investments to provide a steady stream of income to cover your living expenses. If your investments take a heavy loss in the early stage of retirement, the result could be permanently reduced income during the rest of your retirement.
The stakes are higher when investing in retirement. While you’re working and savings, it is possible to ride out periods when your investments go down in value, but the transition into retirement brings the need to tame volatility. By diversifying your investments, you can help mitigate potential losses and increase the chances of your retirement plan succeeding.
#4. An Inflexible Budget
In retirement, it's important to have a budget that is flexible enough to adapt to changing circumstances and expenses. An inflexible budget with a lot of expenses which can't easily be put on hold could force you into making decisions which decrease your retirement security.
A budget with a large number of non-discretionary expenses leads to retirement "fragility" and could potentially lead to cash flow breakdown in the future. Examples of non-discretionary expenses include mortgages, car loans, and second properties, but may also include costs for family obligations such as ongoing support for an aging parent or disabled child.
Even if your budget is manageable under normal circumstances, unexpected expenses such as sudden home repairs or medical expenses may set off a series of required spending which begins to spiral out of control. Knowing in advance how much of your budget is truly essential and how much spending could be comfortably reduced will let you know how much room you have to maneuver in an emergency.
While it may not be necessary to keep a detailed budget throughout retirement, periodically reviewing your expenses and thinking about where you could cut back if required will increase your confidence that you can weather the inevitable storms that come in retirement.
#5. High Investment Fees
The final reason I’d like to highlight is paying too much for your investments. Investment fees, such as management fees and transaction fees, directly reduce the returns on your investments. While a fee of 1-2% may not sound like much, over the long term it can eat away at your retirement portfolio.
When thinking about investment fees, it is important to make sure that you're getting value for the fees that you’re paying. The first step is to find out the total dollar amount of fees associated with your investments. Be sure to include account fees as well as the fees of the investments themselves. It isn't uncommon for people to see the account fee listed on their statements and forget about the fees of the mutual funds they hold.
Once you know the total amount that you're paying each year, you can determine if you're getting value for your money. If you’re receiving financial advice that you find useful for making decisions, then the fee that you're paying may be reasonable. On the other hand, if your advisor only talks about investments and claims that their value is in picking stocks or mutual funds which will beat the market, you're probably paying too much. The long-term track record of investment managers' ability to "beat the market" is poor, and frankly shouldn't even be suggested as one of the things an advisor can help with.
Investors have more choices than ever for how to invest. Taking the time to evaluate your options and review your fees every few years will help ensure that you’re getting value for your money and making the most of your retirement savings.
By being aware of these risks and taking steps to mitigate them, you can help increase the chances of your retirement plan succeeding. If you are unsure about how to address these risks or have questions about your retirement planning, don't hesitate to book a free introductory meeting with me to review your financial situation. Take control of your retirement planning today and set yourself up for a successful and financially secure future.