Hello everyone and welcome to the Retiring Canada Podcast. In today’s episode, we're going to discuss how to make your retirement plan almost indestructible.
Specifically, we are going to cover:
- How to make sense of retirement plans
- The benefits of clear and concise advice
- Two allocation strategies to implement into your plans
- The 7-step process to take luck out of your retirement plan
- The impact of a 1% miscalculation
- And lastly, a few action items for you to consider
Hi, everyone! I hope you are doing well. My wife and I just got back from Mexico last week, and I must say we had a fantastic time! We went to Huatulco (Waa-tool-koh), and it was toasty! We snuck away for a baby moon without our little boy so we could mentally prepare for baby number 2 arriving in May. Thank you to the grandmas and the papas for looking after our little maniac while we were away.
Anyway, let's chat finance stuff.
The creation of a sustainable retirement income is the keystone that all Canadian pre-retirees are searching for.
At the heart of it all, nearly everyone, whether they have 5 million dollars or $500,000 for retirement, has the same question: Will I run out of money?
To answer that question, most advisors might throw out a simple asset multiplier or sustainable withdrawal rate and leave it at that. Some may take things a step further and utilize something called Monte Carlo analysis, which attempts to forecast a range of possibilities to give you your retirement probability of success.
While it makes sense to use the latest software to model retirement, as a professional, I need to know this information inside and out. But there is still something missing from these retirement plans.
What does all this stuff actually mean to you, the client? And I don’t mean what is the definition of a sustainable withdrawal rate or Monte Carlo analysis. What I mean is, how do all these things actually relate to a retiree in plain English?
Think about it. If you meet with an advisor and they tell you that you have a 92% probability of retirement success or that your sustainable withdrawal rate is 3.5%, do these percentages make you feel any better about retiring?
For some finance nerds, it might all make sense, but for most Canadians, this type of financial planning advice just does not compute.
I strongly believe that financial professionals, like myself, need to do a better job being clear and concise when developing and presenting retirement plans. This is the core reason why we developed our complimentary one-page plan process, which I discussed in episodes 4 and 12 of the podcast.
We believe that when we develop a clear and concise snapshot of a client's financial situation, goals, and actionable steps, we facilitate more effective communication between our advisors and clients, ensuring that clients fully comprehend their financial situation and the recommended strategies.
Instead of percentages and charts, why don't we just answer the question: No, you will not run out of money. Yes, you can spend $40,000 helping your kid with a down payment and still be able to retire with your desired income. Or, if you buy that $100,000 RV, you will need to decrease your monthly spending by $500 to ensure your retirement stays on track.
Doesn't that sound better than, "Hey Mr. and Mrs. Client, if you buy that RV, this line turns red on your chart and your Monte Carlo analysis now says 91.5%?"
We think so.
Now, getting back to the meat and potatoes of today’s episode: how to make your retirement plan almost indestructible.
For those within 10 years of retirement or recently retired, there are TWO allocation strategies you need to consider for developing a bulletproof retirement plan.
First is asset allocation. In English, asset allocation is the process of spreading your investments over different types of assets, such as stocks, bonds, and alternative investments. Proper asset allocation is important for diversification—investing in different assets so that if one asset performs badly, you’ll be protected by the gains of another.
Having proper asset allocation is the first step to a sustainable portfolio. To take it a step further, you or your advisor should be monitoring this asset allocation to ensure that one asset in your retirement portfolio doesn’t drift significantly out of your target mix.
For example, let’s say you have a typical 60/40 portfolio asset allocation: 60% equities and 40% fixed income. If equity markets do well relative to fixed income markets, your asset allocation could drift to say 70/30, now extending you into a higher risk level you may not be comfortable with.
If you have a balanced mutual fund, it’s likely being rebalanced frequently to keep those allocations accurate. However, continuous rebalancing can also lead to increased taxes and trading expenses inside your investment, all in the name of maintaining the right asset allocation.
Either way, you will want to ensure the asset allocation of your retirement nest egg is being monitored.
To take things one step further, the rise of alternative investments has created another avenue for retirement investors to add diversification and potentially stabilize returns, reducing the roller coaster ride many traditional investments have experienced over the last few years.
I encourage you to check out episode 16 titled “Pension Style Investing” where I discuss the use of alternative investments in a retirement portfolio.
Now that we have discussed the low-hanging fruit for creating a sustainable retirement income, let’s move forward.
The second allocation strategy you should be considering is income allocation. This is the process of deciding which income sources pay for each category of expenses. There is a 7-step process that provides a baseline for the most capital-efficient way of matching income with expenses. Credit goes to Jim C. Otar for developing and refining this process.
Here are the steps upfront, and I will spend some time on each of them. Also, in the show notes, I will include a PDF sample showing how income allocation may be utilized.
Step 1: Make a list of income from sources other than the portfolio.
Step 2: Make a list of expenses during retirement.
Step 3: Prepare the income allocation chart.
Step 4: Calculate savings required.
Step 5: Make a list of assets available for retirement.
Step 6: Check adequacy of assets.
- If available assets are adequate, then move to Step 7.
- If available assets are inadequate, then review, revise, and recalculate, starting from Step 1 repeat until assets are adequate.
Step 7: Run stress tests.
So, let’s start.
Step 1 is to make a list of your expected retirement income from all other sources, such as CPP, OAS, GIS, pensions, annuities, rental income, business income, royalties, and more.
At this point, do not include income generated from your investments.
Step 2 is to make a list of all your retirement expenses divided into three categories: Essential, Basic, and Discretionary. We want to discern each of these areas of spending and how crucial they are to your retirement success. Every person or couple will be different here. While some may consider helping their kids buy a house as discretionary, others may consider it essential.
We split these expenses into three categories to later align your income sources with these expenses. This is an important step because we want to ensure essential “must-have” expenses are adequately covered with no acceptable risk of failure.
Step 3 is to compile your income and expenses and compare the two. Have a look at the income allocation sample in the show notes for a visual representation. The hope is that your fixed income, such as CPP, OAS, and pensions, fully covers your baseline essentials budget and then determine the shortfall in income, if any, that will need to be generated from your retirement savings.
Step 4 is to calculate the amount of retirement savings needed to address the shortfall in income. This section can get a bit complicated, as we need to make some assumptions about your portfolio allocation, current age, inflation, and more. I won’t bore you with all the details here, but if you want to see how the sausage is made, check out the link in the show notes. For those of you who just want the broad strokes, this step will provide the total amount of retirement assets needed to cover the shortfall from the previous step.
Step 5 is to make a list of all the assets available for your retirement.
Step 6 is to check the adequacy of these assets. If there is a shortfall in retirement assets, the discussion of remedies will need to take place. This could be options such as delaying retirement, saving more, spending less, downsizing your home, selling your home, renting, delaying CPP, buying a life annuity, working part-time after retirement, and many more.
Step 7 is to stress test the findings with major life events that could call this income plan into question. What if markets underperform? What if my spouse passes away and I lose their OAS income and only receive a portion of their CPP as a survivor benefit? What if one spouse goes into long-term care while the other wants to remain at home?
To summarize all of these steps into a sentence: Income allocation involves listing expected income, categorizing expenses, aligning income with essential needs, calculating savings needed for potential shortfalls, exploring remedies if necessary, and stress-testing the plan against major life events.
So why are we doing all this, and how does it relate back to you in terms that are easy to understand? In its simplest terms, income allocation will give you a clear and concise answer to the question, "Do I have enough money to retire without the fear of running out?"
Think of it like a stoplight.
At the end of this process, there are only three outcomes:
Green – Yes, you can retire, and even if your plan hits a snag, you won’t run out of money.
Yellow – Yes, you can retire, but there is a chance a major life event could derail your retirement or force you to make a major decision like downsizing.
Red – Well, I think you know what that means.
In combination, proper asset allocation and income allocation are the one-two punch to make your retirement plan indestructible.
After well over a decade using financial planning software and methods, I can tell you this:
The output is only as good as the input. The results generated by using retirement planning software are only as good as the assumptions used and the attention to detail.
A slight deviation or change in one assumption or input can have a drastic effect on a 20 or 30-year retirement. So tread carefully when using software yourself or placing your trust in the advisor who creates your plan.
Think of it this way. Imagine you set sail on a cruise from St. John's, Newfoundland, destined for France. At the start of the trip, the captain sets course and doesn’t realize that he is 1% off his planned route when plugging things into his navigation. After two or so weeks at sea, being 1% off course puts your ship into the rocky shores of Ireland.
Navigating your retirement is no different. A 1% assumption here and a 1% miscalculation there could put your retirement into the rocks—a place no one wants to be.
So, putting it all together:
I started off this podcast on my soapbox about how professional advisors need to keep things simple—something that continues to be exceedingly difficult in today’s day and age. I really wish there was a silver bullet that you could walk away with, but the truth is that this stuff is complicated to calculate, but interpreting and relaying the results in plain English doesn’t have to be.
As part of our complimentary one-page plan process, we help determine your income allocation and drill down on the expected shortfall, if any. We then work through options and develop your retirement income guardrail strategy to help you answer the number one retiree question: Will I run out of money?
Ok, so action items for today’s episode:
- If you want to learn more about income allocation, I suggest you check out some of Jim Otar’s work online. I must warn you though, Jim is incredibly smart and detailed, and his body of work and calculators can get into the weeds quickly. Check out the resource I put into the show notes so you can get a sense of how this is implemented.
- Check out our process by clicking the link in the show notes to learn more about how we make the complicated easy to understand.
- Be careful. A little knowledge is a dangerous thing. When it comes to retirement and investment planning, most people tend to overestimate their knowledge and can mislead themselves into thinking they are more expert than they really are. In psychology, this is called confirmation bias. Even if you consider yourself an expert DIYer, a second opinion will help ensure you don’t end up eating potatoes in Ireland rather than fine wine in France.
Ok, that will do it for today’s episode.
For the links and resources discussed, please check out the link in the show notes or visit retiringcanada.ca.
If you enjoyed the show, please subscribe and leave us a 5-star review on your favorite podcast app.
Be sure to sign up for my weekly Retiring Canada newsletter.
And hey, when it comes to your retirement, don’t take chances.
Make a plan so YOU can retire with confidence.
All comments are of a general nature and should not be relied upon as individual advice. The views and opinions expressed in this commentary may not necessarily reflect those of Harbourfront Wealth Management. While every attempt is made to ensure accuracy, facts and figures are not guaranteed, the content is not intended to be a substitute for professional investing or tax advice. Please seek advice from your accountant regarding anything raised in the content of the podcast regarding your Individual tax situation. Always seek the advice of your financial advisor or other qualified financial service provider with any questions you may have regarding your investment planning.