Do you become a different person when you retire? Will your values, sense of humour, and pastimes change? Probably not. So why do many investors focus on amassing as much money as possible for retirement instead of considering what their liabilities will be and planning appropriately?
When investors understand their financial liabilities -- the expenses they will need to cover once they retire -- they are better-equipped to change their saving strategy and eliminate fears of not having enough money for retirement. In contrast, a focus on "the number" alone, can make retirement planning extremely stressful. An Allianz study found that 82 per cent of respondents 44-to-49 years old with dependents feared outliving their money more than death.
The best solution is a liability-driven approach that focuses on an investor's exact needs, and mirrors the strategy used by pension fund managers.
Most investors have a fundamental misconception about retirement planning: That it's about maximizing your returns. Instead, investors should focus on risk management: what's the amount of volatility you're willing to accept to get the performance on your account and ensure you won't outlive your money?
Thoughtful retirement planning begins by calculating your true retirement liability, which can prove challenging for many individuals. You may think that you have a complete picture, but focusing on your expenses will help you to reframe the retirement question from "How much money do I need to retire?" to "How much money do I need from year-to-year, or even month-to-month?"
Your lifestyle then and now
A recent survey by Angus Reid revealed the majority of Canadians expect to live until age 85; that's 20 years past their expected retirement age. However, only 26 per cent of those surveyed thought they were saving enough toward retirement. Giving these statistics it's unsurprising that one of the main concerns for retirees is making their money last longer in retirement.
You'll need to have a rough idea of how much it will take to maintain your lifestyle in retirement. With some careful planning and a little luck many of your working life expenditures should vanish in retirement such as your mortgage payments, childcare costs, educations fees and other expenses of maintaining a busy household.
Remember to talk to your financial adviser about your future housing needs. If you're an empty nester or expect to be, it may make sense to downsize so that you can take advantage of the equity that you've built up in your home.
If you're nervous about making your money last through retirement, be judicious about non-essential purchases.
These are just some of the things that everyone should consider when planning their retirement, but they're nowhere near the whole picture. Health care, food, and entertainment should be added, plus travel and anything else you plan to spend money on in retirement.
It's important to figure out what you want to do in retirement and how much will it cost. Remember, the key is to consider how much income you need each year rather than "How much do you need?"
How to figure it out
It can be daunting to relate your retirement liability back to your investment strategy, but here are a few steps that can help:
Get the right attitude. The statistician George Box wrote that "all models are wrong, but some are useful." This is true of retirement planning, too. Often the value of constructing a plan is not in the conclusion, but in the enhanced understanding of the problem you construct.
Get the right partners. A thoughtful financial adviser is your best partner in arriving at a comprehensive solution. In some cases, their value may be most clear around emotional subjects, such as whether to sell the family home or buy that new convertible.
Get the right range of estimates. It's likely that even if you knew with certainty how long you would live and how much you would spend, a financial adviser wouldn't be able to perfectly estimate your retirement liability. The best way to overcome that is to get a range of estimates and reevaluate annually.
It's never too soon or too late to start preparing; having a plan will protect you against panic and rash actions. Take the first step, build a good model, and then watch how much less scary retirement seems.
Robert Stammers is director of investor education at CFA Institute and editor of its Inside Investing blog.
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