Risk and Retirement Do Not Make a Good Mix9
As the prospect of retirement looms, protecting your wealth becomes more important than growing it. Investors must, therefore, grapple with the following three elements:
- The longer life expectancy of Canadians means that they must ensure that they have income for a lengthier period of time. We estimate the expected retirement horizon at about 25 years. And this number increases where there is a younger spouse or in those situations where the family’s longevity history exceeds statistics;
- Inflation which, if left unchecked, can erode retirement savings. Even if it stands at the relatively low rate of 2%, inflation reduces purchasing power nearly 40% over 20 years. To maintain their purchasing power, retirees must see to it that their income keeps pace with increases in the cost of living;
- Market volatility is a major risk factor. In terms of retirement savings, the order of investment returns has a determining effect on the duration of capital. Hence, for a same annual average return (7% in the following example), the capital will be exhausted at an earlier or later time, based on the sequence of returns.
|Sequence of returns||Age of retirees where resources will be exhausted||+/- month|
|+7%, +7%, +7%||86.5|
|+7%, -13 %, +27%||83.3||-38|
|-13%, +7%, +27%||81.1||-65|
|+27%, +7%, -13%||94.9||+101|
In this instance, constant returns will make it possible for the investor to benefit from his/her capital until age 86. However, a downturn in returns at the beginning of the savings period will shorten the amount of time that capital will last, whereas higher returns at the start of the savings period will ensure that it lasts longer.
9 Based on research conducted by Moshe A. Milevsky, Associate Professor of Finance at York University in Toronto and Executive Director of the Individual Finance and Insurance Decisions Center.
10 Source: Asset Allocation and the Transition to Income, Milevsky & Salisbury, September 2006. Example based on a $100,000 portfolio, from which a retiree withdraws $9,000 annually starting at age 65.
This document has been updated on August 31st, 2018 and reflects the state of the Law, including draft amendments, at that date.