Hello everyone, and welcome to the Retiring Canada Podcast!
In today’s episode, we’re diving into one of the biggest threats to your retirement—Inflation.
Specifically, we’ll cover:
Turning on the retirement income tap
The impact of inflation and taxes on your retirement income
The risk of being too conservative with your investments
Why this is the greatest time to be an investor
An inevitable truth every long-term retiree must face
And, lastly, a few action items for you to consider
I know the word inflation has become a hot topic over the last few years, and for good reason. Things are more expensive, and you don’t need me to tell you that—you’re feeling it every day.
During your working years, you hope your salary or business profits grow at least in line with inflation. In Canada, the target inflation rate is around 2%. But when you retire, the game changes. You’re no longer earning a regular paycheck or business income. Now, your investments need to provide you with stable income and keep pace with inflation, which can be daunting for new retirees.
In those early years of retirement, market volatility can make things especially tricky. The choices you make during this period will significantly impact your ability to stay retired. That’s why it’s crucial to have a plan that accounts for inflation, provides stable income, and anticipates market downturns.
But back to today’s main topic: Inflation and how it impacts retirees.
Let’s assume that inflation over the next 30 years averages 2.5%, slightly above the Bank of Canada’s target of 2%.
Now, let’s look at an example:
If you had a dollar and chose not to invest it, by the end of a 30-year retirement, that dollar would be worth about 50 cents—a 50% loss in purchasing power. On the other hand, if you invested that dollar and earned an 8% return, adjusting for 2.5% inflation, your real return would be 5.5%. After 30 years, that dollar would have grown to $5 in purchasing power.
Let’s scale that up to a $1,000,000 portfolio. If you don’t invest wisely, that could mean the difference between $500,000 or $5,000,000 at the end of 30 years. Of course, this example doesn’t account for withdrawals, but it clearly illustrates the damage that poor investing decisions can have on your retirement.
Speaking of which, there’s another factor that further stresses retirement: taxes.
Let’s look at two hypothetical couples, each with a $1,000,000 portfolio in fully taxable RRSP or RRIF accounts. We’ll assume a 20% average tax rate, 2.5% inflation, an 8% average return for a balanced portfolio, and a 4% return for a conservative one. Both couples will withdraw $50,000 annually before tax to meet their income needs.
Couple # 1 got spooked by market volatility and moved their money into high-interest savings accounts and GICs. Their investments earn 4% annually, but after accounting for taxes and inflation, their real rate of return is only 0.7%. As a result, they’ll run out of money in 20 years.
Couple # 2 took a balanced approach with a well-diversified, low-cost portfolio, earning an average of 8%. After taxes and inflation, their real return is 3.8%, allowing their money to last nearly 40 years.
So, what’s scarier: watching your portfolio fluctuate or running out of money at 80? The bottom line is, being too conservative can ruin your retirement.
If your portfolio is full of GICs, fixed-income funds, or high-interest savings accounts, I urge you to do the math. Even if a GIC is yielding 4% or 5%, after taxes and inflation, your real return might not be enough to keep you retired.
Now, I’m not saying that conservative investments are bad. In fact, stable investments are essential during times of market uncertainty. But they need to be balanced with investments that can outpace inflation over the long term.
Remember, the stock market is the greatest wealth-building tool in history. For example, you can invest $100 in a low-cost ETF and instantly become part-owner of some of the world’s largest and most profitable companies.
That said, I’m not giving you personal investment advice. Everyone’s situation is unique, and so should their retirement strategy. When building a retirement portfolio, your timeline, risk tolerance, and risk capacity must all be considered.
As a financial advisor, assessing a client’s risk capacity and tolerance is mandatory. It’s the backbone of my relationship with clients. However, what often gets missed in these conversations is the danger of being too conservative.
It can be uncomfortable to watch your investments fluctuate, especially when you rely on them for income. But that’s why you plan ahead, shifting your income withdrawals to more stable investments during downturns.
I tell my long-term retiree clients: it’s not if the market will go down, but when. Accepting this inevitability is key to being a successful long-term retirement investor.
Action Items:
If you’re the type of investor who avoids market fluctuations and only holds conservative investments, I urge you to calculate your after-tax real rate of return. You can find the formula easily online.
If your advisor has you sitting primarily in cash or cash-like investments, they’re no better than a stock picker. No one can predict the markets, and trying to do so is a fool’s errand. Think like a long-term investor. For more on this, check out Episode 32 of this podcast.
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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.