In a recent speech at the Canadian Institute of Financial Planners annual conference in Ottawa, Peter Drake, vice president, Retirement and Economic Research, Fidelity Investments Canada ULC called attention to the new retirement realities facing Canada’s baby boomer generation and highlighted the importance of taking account of the five key risks to retirement income as part of the retirement planning process.
Drake emphasized that the conventional wisdom about retirement planning needs to be adapted to suit the new environment faced by today’s Canadians who are retired or about to retire. He pointed out that financial advisors can play a crucial role in helping Canadians understand that their retirement planning choices must not only reflect the longer lives we are now living and the volatility of capital markets, but also changes to Canada’s retirement income system.
“Financial advisors and investors will need to work closer than ever before to identify the level of risk that is acceptable to the individual investor, while managing the sometimes conflicting goals of adequate pre-retirement income replacement, capital preservation and long-term growth,” said Drake. “A retirement income plan that addresses the five key risks to retirement income can considerably improve the financial well-being of Canadians in retirement.”
The five key risks to retirement income are:
1. Longevity risk
Canadians are living longer and healthier lives and many have ambitions to retire earlier than their parents. There is a 50% chance that at least one member of a couple both aged 65 will live to age 90 and a one-in-four chance that at least one member will live to 94. As active, healthy lifestyles and medical advances continue to extend life expectancy, Canadians will have to consider how early they can afford to retire and plan for the real possibility that they’ll need 25 to 30 years of post-retirement income.
2. Inflation risk
Inflation is a big concern for many retirees and even if the government fiscal and monetary stimulus used to fight the global financial crisis does not result in higher inflation, inflation is still a threat to retirement plans. While high inflation, such as that experienced in the 1970s is unlikely, even a modest 2% inflation over the span of a 25-year retirement—approximately the same rate as the past 20 years—can erode a retiree’s purchasing power by 40%. Retirees need investment portfolios capable of keeping up with inflation.
3. Asset allocation risk
The 2008-2009 crisis heightened anxiety about the stock market. But historically equities have provided long-term growth that is critical in providing needed income in retirement. A diversified portfolio that includes stocks, bonds and cash helps provide growth as well as protection against market volatility.
4. Withdrawal rate risk
The increased volatility in the stock market over the last few years has highlighted the need for conservative withdrawal rates that help ensure one’s investments last as long as a person’s retirement. The risk of outliving one’s investments rises with annual inflation-adjusted withdrawal rates over 4-5% of the original value of the portfolio.