This article is the seventh in a series on personal finance and investing at different stages of your life. As some issues may overlap the different stages of life, they could be covered in a prior or subsequent article. For the full series go here.
Financially, the fifties and sixties are a sweet spot in the life cycle. Job income is at a peak and obligations, such as kids and mortgage, have dwindled or disappeared. It's a time when many people can ratchet up savings for their retirement years.
Yet, pitfalls lurk. For Jean Lesperance, author of the blog Canadian Financial DIY, they came with his pension plan. “My worst financial move was taking the commuted value of my public service pension instead of just leaving it there till retirement,” he recounts.
The best time to start thinking about retirement is several years before you clean out your desk for good. Then you will have more time to pursue options that will make your golden years more comfortable. Here are 10 pointers to help you avoid some of the pitfalls when planning and investing for retirement.
1. High allocation to stocks?
What is the best investment strategy for someone just starting to live off withdrawals from a registered retirement income fund or other retirement fund? Conventional wisdom dictates a small exposure to stocks. For example, Gordon Pape on his website, www.buildingwealth.ca, recommends “not more than 25 per cent of a RRIF's assets be held in stocks or equity funds.”
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York University professor Moshe Milevsky has a different view. For him, the problem with going mostly to fixed-income securities is the increased risk of outliving retirement nest eggs, especially in this era of longer life spans and low interest rates. He prefers higher allocations to stocks because their historically superior returns can deliver more growth to invested funds.
Mr. Milevsky has run, using the Monte Carlo technique, millions of computer simulations on hypothetical retirees with different withdrawal rates, life spans, start dates, asset allocations and other relevant variables. As discussed in his book Are You a Stock or a Bond? , those simulations have found that the chance of outliving retirement funds fall as the allocation to stocks rises – with the optimal weighting being 60-per-cent to 70-per-cent stocks. Such an emphasis on stocks also protects better against inflation risk.
2. Hedging longevity and other retirement risks
While higher allocations to equities help lower the probability of outliving funds (known as longevity risk) and inflation, they still don't eliminate them. In fact, a particular problem with equities is the “sequence of returns” risk. This arises when a retiree begins a program of systematic withdrawals from their retirement fund just as the stock market goes into a bearish phase. The withdrawals leave less capital to appreciate in value when the bullish phase returns, exposing it to swifter depletion.
