How much is enough for retirement?

Keith Pangretitsch: I would agree with Scott. There are definitely different levels of complexity, and different challenges. There are three main areas around retirement: essentials; lifestyle; and estate.

We always say every dollar a client has should have a job description. I think one of the mistakes we make in this business is the fact that we just look at the portfolio as one big lump sum. We feel the job description has to match the risk tolerance of the portfolio. If the job description is certainty, we’d be aiming for a pretty conservative portfolio —something in the range of 65% of fixed income; 35% of equity. Once we’ve got that one covered we move to the next one—lifestyle. The job description for that is discretionary. So we recommend being a bit more aggressive. Finally, if your only goal is to provide for your kids—and that’s 30 years out—that portfolio can constitute 30% equity. If you are not going to touch the money and you have a 30-year time horizon, buy stocks. The potential of stocks outperforming bonds and cash over that time period is about 98%.

Recession’s impact

Robertson: I haven’t changed any of the assumptions I base my retirement projects on. I think clients are always a little more sensitive to the downside possibilities than they might have been. But one of the strategies I followed during that period of market re-pricing was to go back to that basic core analysis. What I present to clients is what I call a sustainable spending rate. Most of my clients—with various levels of comfort—stuck pretty well to the asset mix targets we had set. In some cases they said: “We’re not going to re-buy equities every month, we’re going to let it drift and come back.” They weren’t panicking; they stuck pretty close to the asset mix target they had set originally.

Pangretitsch: Our assumptions haven’t changed. For people who are five, 10 or more years from retirement, the impact from this recession will quite likely be not that significant. It is people who have either just retired or are just about to retire who will be most impacted.

We need to do a lot more planning and fact-findingon an individual basis to determine who is impacted and the options those individuals have.

Increased life expectancy

Robertson: I always project through to the age of 100, assuming one of the couple will be alive at that point. That actually was a change from my original assumption, which was age 90. The only thing worse than dying poor is living poor. So I’m fairly conscious of not having a client left without assets at the age of 100. So I build a fairly conservative model.

Pangretitsch: I think there are a couple of trends going on here. Life expectancy is going up at least two years each decade. I think the other growing trend is people retiring earlier. So there’s a bit of a double whammy from a retirement-income perspective.

When I look back 30 years, the average age of retirement was 66 for men and 64 for women. Today that number is down to 62 for men and 61 for women.

That’s basically a four-year differential on when people are retiring. And then people are living longer. You add those two together and that’s another ten additional years that people are going to spend in retirement. I think it’s having a pretty significant impact on retirement.

Inflation, return averages, volatility, asset allocation, and lifestyle

Robertson: When I’m talking about investment returns, I’m taking a look at a longer-term trend and I’m using that on an after-tax basis, after-inflation basis. So that’s really where I’m building in the return and inflation parameters.

It’s more of holding on to that plan, keeping that plan in place. I’m dealing with clients who understand asset allocation. It’s pretty clear that over the longer term the equity markets are going to perform. It’s just a matter of how much equity you want to take on. About lifestyle, I’m only doing a 50-year projection. We’re projecting it every year. I do that retirement plan on an annual basis.

Pangretitsch: Inflation, returns, volatility (asset allocation), and lifestyle (spending and longevity) all have a predictable impact on portfolios. Higher returns are going to lower the amount of money you need for retirement, but will provide less certainty because you will have to take more equity risk to achieve higher returns.

Inflation and lifestyle have a positive correlation to the amount of money you need to save. The longer your life expectancy, the more money you spend in retirement, and the greater the inflation rate, the more money you will need to save. We suggest a reasonable return expectation is in the 6% to 8% range with a spending rate of between 4% and 6% to accommodate for inflation. The probability of success at a 4.5% spending rate is equal for almost all asset allocations at around 70%. At a 6% spending rate the probability of success for a 20% equity portfolio is essentially zero and is 40% for a 80% equity portfolio.

Is it possible to bulletproof a retirement plan?

Robertson: In one word: NO. I think there are always uncertainties out there. Lifestyle is always going to be vulnerable to the vagaries of the markets, and the economy. You can’t get anything that’s going to have 100% inflation protection. You have five years of double-digit inflation and that’s a couple of bullet holes in your bulletproof plan.

Pangretitsch: It’s pretty tough. The closest you’re going to get is if you can buy an annuity with an inflation adjustment and a last-to- die 100% survivor option or a rock solid defined benefit plan. The best way is to make a heck of a lot of money and have a whole lot of financial flexibility at retirement.

Robertson: You know the old expression: work expands to fill the time allocated to it. The same thing applies to money. If you make a lot more money, people find other ways of spending it. I don’t think even having a lot of money provides a bulletproof plan. Retirement is an ongoing series of financial decisions.

How often do you update retirement plans?

Robertson: When I take a look at a retirement plan I go back to the core model of the planning I do, which is giving that sustainable spending rate. So I update that on an annual basis, unless there’s a reason for doing it more frequently. Part of that entails having that discussion about lifestyle, and what the implications are going forward.

Pangretitsch: We recommend goals-based reporting, at least for the investment proposition. Every time a client comes in, we should probably update the progress of the portfolio relative to the goals and take appropriate action if necessary. Oftentimes the appropriate action is to do nothing. From a broader wealth planning perspective for things such as changing spending, insurance, and health needs as well as life goals these should be reviewed in detail every two to three years.

Planning for uncertainty

Robertson: I’m constantly telling my clients it’s the long term, it’s not the short term. What happens in the short term may be uncomfortable, but it isn’t significant to the plan.

I go back to the basic assumptions. I go back to that long-term analysis. When I give a plan to a client I’m painting three to 15 different scenarios for the client to choose from. I give them a spectrum of possible plans based on assumptions in terms of retirement date, investment returns, lifestyle changes, changes in real estate, upscaling, downsizing, whatever the case may be.

I guess I have a very fluid view of how people live their lives.

Pangretitsch: I think this business, and advisors as a whole, have added a tremendous amount of value to investing. Are we doing it perfectly yet? No. I think one of the biggest challenges we have is that advisors still treat investment portfolios as one lump sum piece of money. They put their client through some sort of flawed risk questionnaire. I say flawed because the answers they gave in 2007 are certainly not going to be the same in 2008. So they get dramatically different outputs from that.

Then they put those outputs into a modern portfolio theory, such as the efficient frontier program, which in my estimation is more for an institutional plan.

Institutions and individual investors are different. The institution is supposed to last in perpetuity, so their risk parameters are different, whereas individuals have predetermined retirements and an end date. Modern portfolio theories imply is there are no emotions. But our clients have a ton of emotions.

There’s one thing I think we could do differently: break that retirement nest egg into job descriptions. What is the money supposed to do, and how to best meet client have, which require separation of the asset pool and different strategies.

How much does one need in retirement?

Robertson: The factors depend on the things the clients can control—spending rate; lifestyle decisions—to things well beyond their control—investments; economy, and things such as inheritances.

The longevity of my parents will definitely affect how much I’m going to be able to spend. So there are a huge variety of factors. But if I had to put my finger on the number one factor, it would be clients’ spending rate. That’s the one that’s going to have the most impact in terms of the way they retire, and the way they save now.

Pangretitsch: For us there are five distinct factors: saving; investment returns; spending; and longe-vity. I think the reason this topic is causing so much anxiety is because of the factors we don’t control: longevity and investment returns.

So 50% of what we’re supposed to focus on, we don’t even control. Whenever we’re doing a plan we look at all those things and try to put our best assessment around those things to come out with an outcome that’s going to meet the goals.

How much is enough?

Robertson: The spectrum of clients that I have is rather wide, and I’m dealing with a small group. Those magic figures don’t make sense. There are people who’ve got a lot more money, and people who will survive very happily on a lot less money.

Whether it’s a newspaper article or a book that comes out saying you need X number of dollars, I think it’s pretty superficial in one way.

But at least it gets people thinking and hopefully going out and seeking some advice. Putting a dollar amount on retirement is not a germane discussion.

Pangretitsch: I think retirement is far too important, and far too individualistic to come up with a number. But if we’re going to play the game, we’ll take that average number, and we think it’s somewhere around $300,000 of savings that the average Canadian needs for retirement. This takes into consideration CPP and OAS. For the average person it’s probably not a bad number, but then who’s average?

When should one start saving for retirement?

Robertson: If a 30-year-old couple is scrambling to pay down their mortgage payments, I consider that part of their retirement planning. If they are spending so much that they’re getting further in debt, then that’s a problem. But if they’ve got a discipline to start saving by paying down their mortgage, then 45 years to 60 years is probably the major time of accumulation of assets outside of their house.

Pangretitsch: The nice answer is: you start as early as you can. But life gets in the way. For me personally, it was probably easier to save money when I was in my 20s and early 30s than it is now. You start as early as you can, but in your 20s you’re just getting by, paying your rent and food and going out with your friends. In your 30s you’re starting that down payment, or at least starting to save up for your down payment, and doing things like that.

It’s in your 40s that you actually have enough money and start aggressively paying down that debt. It’s really in the late 40s and early 50s that average Canadian starts to save.

Investing, when done right, is intended to allow you to live the same lifestyle in retirement as you did during working years, not take you from making $50,000 a year to living like a millionaire in retirement.

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Vikram Barhat is senior reporter, Advisor Group.

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