Retirement planning should be a sure thing

People are living longer. Statistics Canada tells us that between 1979 and 2004, life expectancy at birth rose by 5.3 years. Over the same period, life expectancy at age 65 (which is always higher than at birth) rose by 2.6 years.

Statistics Canada — quite sensibly and cautiously — assumes that longevity will continue to increase, but at a slower rate than in the recent past. That means your clients can expect to live beyond the 77.8 years for men and 82.6 years for women average life expectancy at birth. Canadians who have already reached age 65 years see their life expectancy increase to nearly 83 years for men and the 86 years for women. Remember that these are averages. Since your objective is to ensure that your clients don’t outlive their retirement assets, you should plan for them to live longer than the numbers cited by Statistics Canada.

People are retiring earlier. Twenty years ago, the median age of retirement was 65. Now, it is 61. Combine that with longer life expectancies and it is easy to see that a new retiree could experience a retirement as long, or even longer, than their working lives. Median retirement ages aren’t static. The long-term trend has been down, but they also fluctuate with the business cycle (to put it more bluntly, companies tend to “retire” more employees when economic times are tough). Those who look closely at the statistics will also note that the median retirement age has begun to creep up again, but it is too early to tell if the long-term trend toward younger retirement is beginning to reverse.

People don’t necessarily plan to downsize their lives in retirement. It has been a basic tenet of retirement planning that people downsize when they leave the working world. Some are forced to downsize because of financial constraints; others downsize by choice. But increasingly, clients are planning to maintain their lifestyle in retirement. A few even attempt to upsize. Recent research we did at Fidelity (covered extensively in a previous column) concluded that a replacement rate of 75 to 85% of pre-retirement income is required to maintain pre-retirement spending.

Clients make uninformed choices between consuming and investing. The choice between consuming now and investing to be able to consume more in the future is one of the oldest economic problems out there. Obviously, clients need to consume, but they also need to invest in their future by saving for retirement. There are no simple answers as to how to make these choices. Every client’s situation and attitude is different. You can help give the client perspective. For example, you might help by comparing rates of returns on investments with rates of depreciation of automobiles. Discuss the financial merits of postponing a major consumer purchase versus making it now. In this way, you can help a client decide — on rational economic grounds — how to optimally allocate funds between consuming and investing.

Clients focus too much on short-term issues when investing. Clients face plenty of distractions when they invest. Day-to-day fluctuations in financial market performance and the reams of investment news bombarding a client every day can get in the way of a longer-term focus. Poorly performing equity markets mean RRSP contributions will fall. What many clients fail to grasp is that making regular retirement savings contributions and investing them — even if the return is temporarily low or negative —is the single most useful thing they can do to prepare for retirement. How many clients actually make up “postponed” contributions to retirement saving when markets turn up?

Clients miss the point of investing early and regularly. Recently, my colleagues looked at over 250 30- and 15-year savings horizons between 1956 and 2006. Assuming a retirement age of 60 (one year less than the current median retirement age in Canada), and a portfolio invested with a balanced asset allocation, they examined how an individual saving a given amount of money per year (say, $1,000, $10,000, etc…) starting at age 30 would fare at retirement compared with one saving twice that amount, but starting 15 years later at age 45.

Most advisors already know the results, but they are well worth reviewing. On average, the individual who saved half as much but for twice as long (30 vs.15 years) ended up with nearly three times the wealth of the individual who saved twice as much, but for only half as long. In fact, historically the late starter needed to save close to six times more per year to accumulate the equivalent wealth of the early starter at retirement

Furthermore, even over the worst savings horizon, that is, when saving less for longer was least advantageous, the early starter still amassed 95% more at retirement than the late starter. Over the best horizon, the early starter was ahead by a whopping 260%.

Much of this may sound frighteningly familiar. Yet, there is a fairly new branch of economic thought — “behavioural economics” — that is finally grasping what advisors have known for years: people don’t always act rationally, they don’t necessarily have will-power and retirement outcomes are poorer as a result. Behavioural economics doesn’t offer any new insights as to how advisors should persuade their clients to save for retirement. It reminds us, however, along with current demographic and retirement trends, that clients really do need your help, and no matter how you look at it, retirement planning is here to stay.

Peter Drake is vice-president, retirement & economic research, at Fidelity Investments Canada. With over 35 years’ experience as an economist, he leads Fidelity’s research efforts in examining retirement in Canada today. He can be reached at peter.drake@fmr.com.

(08/08/07)