They are considered golden rules of investing, designed to address investors’ two biggest questions about retirement: How much money will I need and how do I make it last?
But experts at some of Canada’s largest financial institutions say the 70-per-cent rule – that you will need 70 per cent of your previous income after retiring – and the 4-per-cent rule – that if you withdraw 4 per cent of your nest egg each year, adjusted for inflation, it should last for 30 years – need to be retired themselves.
“I don’t like golden rules, generally speaking,” says Jason Round, a senior manger at Royal Bank of Canada Financial Planning. “People are looking for something simple that they can hold on to and say, ‘Okay, if I can do this or strive toward this, then I’ll be fine.’
“But you need to really think about it a little more and have more of a plan that’s personalized to you.”
The 70-per-cent rule
“I’ve always had difficulty with this one,” says Robert Gorman, chief portfolio strategist at TD Waterhouse Group Inc.
That’s because it’s a general rule of thumb that is used to address a very specific – and crucial – circumstance: a person’s retirement requirements, which vary hugely depending on that person’s preferences and obligations.
He cites the examples of two couples heading for retirement: one with no mortgage, no kids living at home and a lifestyle that is anything but ostentatious, with low-key plans to travel and entertain; the other with a substantial mortgage, consumer debt and the desire for expensive travel and frequent entertaining.
The first couple, Mr. Gorman says, could probably manage on 50 per cent of their preretirement income; the second would probably require close to 100 per cent.
“That difference – from 50 per cent to 100 per cent – is certainly not beyond the realm of my own experience and observation,” he says.
Even among individual retirees, preferences and obligations can vary dramatically, RBC’s Mr. Round says.
“It’s actually like a wave,” he says. At the beginning of retirement, many people decide to take advantage of their good health and robust savings and fulfill lifelong dreams, like big-ticket travel. Then, when they become less active, they choose to stay closer to home and spend less. Later on in retirement, their needs may climb again if they are dealing with significant health issues.
Health care is the wild card in retirement, Mr. Gorman says. It’s tough to plan for poor health and many just don’t, he says. Even those people who factor it in often see “their best-laid plans go awry.”
Mr. Round says that rather than following the golden rule of 70 per cent, people should go through the process of setting their goals – “their personal picture of what retirement might look like” and from there “attach price tags” to come up a plan to fund retirement.
Gaetan Ruest, the Winnipeg-based assistant vice-president of product and corporate research with Investors Group, suggests concentrating on your retirement expenses, rather than income. The process, he says, should be to set your goals, figure out the expenses you’ll be incurring in retirement, deduct from those expenses any money you’ll be getting from your pension plans and government transfers. The difference between expenses and the money you’ll be receiving is what you need to save for.
The 4-per-cent rule
Developed in the early 1990s using studies that looked at inflation rates and the historical returns of markets, the rule was devised to address the critical issue of longevity of savings. The equation adopted by many financial planners was that if you withdraw 4 per cent of your savings each year, adjusted for inflation, your nest egg would last 30 years.
But, Mr. Gorman says, that was then, this is now: Canadians, who as a whole are very conservative investors, tend to enter retirement with portfolios that are highly weighted in fixed-income. With bond yields currently being very low, returns can’t sustain the 4-per-cent withdrawal rate.
“If you have a bond total return of 2 or 3 per cent, then clearly – to state the obvious – 4 [per cent] is not possible without dipping into your capital every year,” he says. “A high fixed-income rate, which has generally worked fairly well for the past 30 years, is just not going to cut it.”
And that doesn’t incorporate inflation. Mr. Ruest says that even if retirees have returns that allow them to withdraw 4 per cent, a significant chunk of that will go toward paying for inflation.
It also can make a difference when you retire. Mr. Round says the sequence of returns is crucial, citing the example of a person who retired a few years ago, when markets were at their lows. “If your portfolio was down 10 or 15 per cent and you were withdrawing in that environment, you would be in a much different position than someone who has a stable first couple of years of returns.”
Life expectancy is also a factor, Mr. Ruest says: With a lot of people are living past 100, planning for 30 years may not be enough.
For Mr. Gorman, Canadians have to make hard asset-allocation choices in the current low-yield environment, especially if they hope to follow the golden 4-per-cent rule. That means a higher weighting of equities in their portfolio.
“The only way you are going to make this fly is if you have significant weight in equities, which if they just get returns along the lines of earnings growth, we’ll call that 5 or 6 per cent. Plus 2 per cent in dividends returns, so let us say conservatively 7 per cent.”
He advocates equities with a moderate degree of volatility, like dividend growth stocks with a relatively high dividend and a record of increasing that dividend over time.