Imagine that you have just retired and have booked a meeting with your financial advisor to share this exciting life event. After sharing the news you spend time talking about your first big travel plans and all the things you want to do – things that cost money. The conversation naturally shifts to your investments and whether or not you should change strategy.
When it comes to investing in retirement, the period can be thirty years or longer. This is a long period in your life and for many people, they require some growth during this period as well. When interest rates were higher it was definitely advised to shift to a more conservative asset mix with a higher percentage in fixed income investments, such as corporate bonds, provincial bonds, federal bonds, coupons, GICs, term deposits, debentures, notes, and preferred shares. Many of these interest bearing investments today do not exceed the rate of inflation, and certainly the estimated return would be on the low end of any financial plan prepared in the past.
It may be a daunting task to plan the next thirty years of your life in retirement. By planning we are really looking at how you see everything in retirement unfolding and then looking at the associated costs of the things you need and want. Breaking this thirty year period into three decades is perhaps more manageable. Let’s refer to the first ten years as the Early Retirement Years (ERY). The second ten year period will be referred to as the Middle Retirement Years (MRY). The last ten years of retirement will be referred to as the Final Retirement Years (FRY).
Before you enter the ERY, it is useful for you and your spouse (if applicable) to have a clear understanding of the costs of the things you need. These should be the amounts that are clearly outlined in your financial plan. Ideally before the ERY starts you should also look at the things that you want. Putting plans down on paper really helps map out options and the associated costs of each decision. One couple may want to purchase a sailboat of their dreams. Another couple may want to purchase a motorhome and explore North America. Possibly flying to a warmer climate every winter or travelling the world is the agenda. Planning the first ten years of your retirement before it begins will better ensure that you focus your resources in the best areas and that you make the most of your time. Once options are discussed then it is easier to communicate this to your advisor and determine the cash required for the things you want to do. Again, this is different from the things you need. Before, and during, retirement it is important to let your advisor know what cash you require for both the things you need and the things you want.
A recommended approach is to create a cash reserve, also known as a cash wedge, equal to the amount of cash required for the upcoming year. With increased volatility it may be prudent to increase your wedge to two years to cover your cash flow needs.
Using Mr. Wilson as an example, he is 60 years old and has $1,000,000 to invest. He would like $5,000 a month transferred from his investment account to cover his needs. Annually this is equal to $60,000. In the next year Mr. Wilson feels he will need a new car, which he estimates after the trade-in to be a difference of $25,000. Mr. Wilson’s cash wedge should be in the range of $85,000 – $145,000. The lower end of the range is calculated by his needs $60,000 x 1 year plus his wants $25,000. The upper end of the range is calculated by his needs $60,000 x 2 plus his wants $25,000. This wedge will ensure that cash is available when required.
As a general rule of thumb, you will spend more money on an annual basis in the ERY then the MRY. The reason for this is that you may have capital purchases and more expensive plans during this period. This is the period in which most people have good health and the desire to do things. This period has lots of changes, including beginning to receive CPP, OAS, and other pension income. You may find that you want to volunteer or work part time, or spend time with new grandchildren. Certainly you will likely have to adjust to spending more time with your spouse. Developing new interests, hobbies, and friendships are important, especially if you’re planning to spend your retirement close to home.
The MRY is generally the decade with more stable cash flows when compared to both the ERY and FRY. By this time you have a clearer understanding of your cash in-flows and out-flows. During this period you will be required to convert your RRSP to a RRIF. We also advise during the MRY that you should ensure that all your legal documents are in place (powers of attorney, representation agreement, and updated will). This is important to be done when you have your health and have the capacity to make decisions. It is during the MRY where you may sell your personal residence or begin thinking about selling it. The decision about whether to sell your personal residence during the later part of this stage is often linked to your health.
Depending on your life expectancy, the FRY may be shorter or longer. Generally during this stage, the costs are mostly associated with the things you need. The FRY are the toughest to plan before retirement begins. It is more in the late MRY where you will begin thinking in greater detail about where you want to live as you age. Some people may have a home that is easily accessible and suitable for growing old in. Others may look at other options including: modifying/renovating home, buying another home with lower maintenance, renting, or moving into an assisted living arrangement. Provided you have a home that is fully paid for, the equity that you have built up in your home should cover the costs associated with the Final Retirement Years. I’ve seen many creative ideas, such as building a suite in a home to have a caregiver, or family member, living in the home for assistance. Planning for thirty years in retirement will help you prepare for all three stages and the associated financial costs of each.