Monitor your progress
Portfolio reviews are an important part of any retirement plan but the focus is often placed solely on performance without taking other important factors into consideration.
Part of the problem stems from the fact that many investors don’t have a plan in place. In other words, they don’t know how much they should have set aside by the time they are thirty-five, forty-five or fifty-five. As a result, they look for other measurements to determine whether or not they are succeeding or falling short.
The easy choice is investment performance. If they are expecting 7% and only achieve 6%, there is disappointment; if they achieve 8%, there is a sense of well-being.
While the rate of return on your investments is the most widely discussed aspect of financial success, it is only half the story; accumulation of capital for retirement is the real goal. That accumulation is achieved by a combination of the return you earn on your investments and your personal contributions to your portfolio. The best returns in the world don’t do you much good if you have made only token contributions.
A great many Canadians operate without setting that target for the amount of money they need to save. Some avoid the topic altogether and take an ad hoc approach to setting money aside.
Set a target
There are those who advocate that you maximize your RRSP contributions, others suggest you automatically contribute 10% of each paycheque into an investment plan and some say you should do both. Now that TFSAs have been introduced, you now have another account which can be used to save for retirement.
While all of that is fine, it doesn’t provide you with any information on whether one or all of these strategies will meet your needs. It is just an open-ended suggestion.
Let’s assume that the average income for Canadians in 2008 was about $45,000. The maximum RRSP contribution would be $8100 for someone without a pension plan, a 10% savings plan would be $4500 and the maximum TFSA contribution would be $5000 for a total of $17,600.
On the other hand, according to Statcan, only 50% of Canadians participated in a private retirement savings plan in 2008 and those who did contributed an average of $2700 to their RRSP accounts.
That is a huge discrepancy between what some financial planners suggest for retirement savings and what actually happens in real life. But the real problem is that whether you contribute $15,000 per year or $1,500 per year, you have no idea if you are on target, ahead of target or behind target.
You need to establish some kind of a goal so you can monitor your progress.
In a lot of cases, people may not have been saving enough because they had no idea of what was required. In other cases, some may have been unnecessarily sacrificing their current lifestyle and saving everything for the future. It is important to strike a balance between living well today and saving adequately for the future.
Measure Your Progress
As I mentioned, investors may become fixated on returns rather than the amount of capital they have accumulated. While returns are important, you can agonize over a bad year in the markets when, in reality, your plan might be right on track. Here’s an example:
A hypothetical investor has determined he needs to accumulate $500,000 to retire at age 65. He is currently 55 years old, he is contributing $12,000 per year to his portfolio and it is currently worth $200,000. While his rate of return is good in some years and bad in others, he expects to earn 6% per year for the next ten years.
Is he on track to achieve his goal? If he isn’t, what does he need to do to get back on track? If he is on track, what should his portfolio be worth when he is 58 or 61 years old? How should he monitor that?
In reality, he only has a vague idea of where he stands.
Keeping a scorecard that compares the actual value of your portfolio with what you need to have is a good way to keep on track. If you are having trouble setting one up or don’t know how to get started, your financial advisor can help.
The target year end value and the actual year end value can be easily rather than later. The values do not have to match penny for penny. As long as the actual year-end value isn’t more than 10% from the target year end value, very little, if anything, needs to be done in the way of adjustments.
Using the example of our 55 year old investor, a scorecard might look something like this:
In this case, the hypothetical investor has realistic expectations. His contributions, along with average annual growth of 6%, should help him achieve his goals. The scorecard helps to monitor whether he is still on track and whether adjustments need to be made to the level of contributions.
There may be instances where the actual year end value is less than the target year end value. The solution is not adopting a more aggressive strategy than what is appropriate; the solution is to contribute more than you had originally planned until you do catch up. It can be a lump sum contribution, or it can simply be an increase in monthly savings, that allows you to catch up over time.
There may also be instances where the actual year end value exceeds the target value. If that is the case, you should resist the temptation to reduce contributions. Murphy’s Law could unexpectedly apply and the following year could turn out to be less than expected. A bit of a cushion is never a bad thing.
Once your scorecard is set up, there is very little activity required. Once a year you can sit down and total up the value of your portfolios and input the actual year end value. It might take five minutes per year and is an invaluable tool for helping to keep you on track.
A second scorecard can be set up when you retire. It would be similar to the pre-retirement scorecard but it would monitor the value of your portfolio as you withdraw money for income, rather than when you are adding money for growth. Both help to keep you on track by identifying any adjustments that may be necessary.
In the example below, the investor has chosen to begin withdrawing $30,000 from his portfolio at age 65 and wants to increase that withdrawal each year by 2% to account for inflation. This table does not reflect his total income, only the amount he hopes to withdraw from his portfolio.
His other sources of income might be the Canada Pension Plan and Old Age Security.
He has chosen a growth rate of 5% on his portfolio, which is lower than his pre-retirement growth rate because the portfolio will be more conservative and will need to generate income.
This scorecard indicates that the investor would be able to withdraw an inflation-adjusted $30,000 per year from his portfolio until age 88. As in pre-retirement, this scorecard helps him to monitor his progress and it illustrates whether any adjustments need to be made to the income.
For those who are retired, it is comforting to be able to check your money situation and see how it is doing. That way you can tell if you have a good cushion or if you have to make some adjustments.
The report created when you use the SmartPlanner on MoneyPages https://moneypages.ca/smart-planner/index provides you with a scorecard that combines the accumulation years and the retirement income years, allowing you to easily monitor your progress to determine if there are shortfalls or surpluses.
There are only a few ways to reasonably handle any shortfalls in your financial plan. Cutting back may not sound like fun but once you are retired your options are limited. It is the reason I encourage investors to build in a cushion or margin for error.
The pursuit of higher returns
Some investors tend to become more aggressive with their portfolios when they fall behind in their savings goals. They want their investment portfolios to do all the work and if there is a shortfall they will just crank up the risk profile in the hope of a higher return.
A problem occurs when the returns don’t come but the risk does. When you are retired, one big market correction can turn a bad situation into a complete disaster. Instead of solving the problem, it only becomes worse.
The worst way to make up for a shortfall in your financial plan is to pursue higher returns by taking risks that are unsuitable. Yet that is what has happened to many investors over the past ten years.
How many financial advisors have said, ‘if you just hold on for the long term, the markets will rebound and you will see great returns’? It’s one thing if you are 30 years old and have another 35 years of saving in front of you; it is another if you are 60 years old and retirement is looming. It’s even worse if you are already retired.
The US stock market showed almost zero gain for the first ten years of this millennium, while the Japanese stock market has been in a state of decline for twenty-five years!
Encouraging investors to be more aggressive by putting more emphasis on stocks is irresponsible and a prolonged bear market can devastate retirees who have little ability to recoup losses. Investors need to determine their tolerance to volatility and find a way to build a portfolio that matches it.
If trying to achieve higher returns is a dangerous gamble in trying to overcome a shortfall, what other options are there?
The common denominator is that they all involve sacrifice and it is why many people avoid these options.
The solutions available depend upon what stage of life you are at.
Someone who is still working has different options than someone who is already retired. In each case, however, those who are proactive about managing their financial situation can take great satisfaction in overcoming any shortfalls.
If you are still saving for retirement, you can increase your contributions to your savings. If you are already retired, you can decrease your withdrawals. It requires some sacrifice and doesn’t sound like much fun, but it is better than looking for magical answers or ignoring the situation while risking your future.
Those who are still working could also postpone their retirement for a year or two or longer. There is no equivalent solution for someone who is already retired, unless they can go back to work. Again, it is not an easy choice.
The impact of delaying your retirement by one year is can be much larger than you expect. As a suggestion run two identical scenarios through the SmartPlanner (https://moneypages.ca/smart-planner/index) but delay retirement by one year in the second calculation. The difference can be significant.
One solution that is becoming more common is the strategy of working part-time in the early years of retirement. It not only supplements income, it provides a transition in lifestyle from being fully employed to being fully retired.
There is something to be said for that idea on a lot of levels. Even for those who can afford etirement, staying involved in the workforce can be rewarding in many ways.
Andrew Allentuck’s book, ‘When Can I Retire?’ explores many of the options available to those in retirement, including the option of part-time employment.
While some of these ideas may not seem very appealing, taking a risk in the pursuit of higher returns is an even poorer idea.
The good news is that if you set some realistic goals, develop an investment plan and stick to investment choices that suit your situation, then the chances are it all should work out. Adjustments to your plan should be minimal and relatively painless.
For some people, it may seem like a lot of work and may sound complicated.
They may approach retirement planning by saving what they think they can afford, letting it build up over time and hoping everything works out. The trouble with this approach is that there is always something that seems more important than saving for the future.
Paying yourself first and setting aside 10% of your paycheque for savings is a good idea but it isn’t retirement planning. No goals have been set and you have no idea if you are on track or not. Your monthly savings are a tool you can use to help make your plan work, but they are not your plan.
The best strategy is to develop a plan and then measure your performance.
That doesn’t mean measuring the rate of return on your investments and nothing else; it means checking on your progress to see if you are accumulating enough capital. The more often you check, the more likely it will be that you stay on track.
If you have no interest in these matters, have no time, or have tried it and feel you have no expertise, find a financial advisor who you are comfortable working with. Once you have decided that you have found the right person, tell them what you want to achieve and give them all the information they ask for.
Your chances of success will improve if you take these simple steps.
This is a Heading
This is a paragraph. To edit this paragraph, highlight the text and replace it with your own fresh content. Moving this text widget is no problem. Simply drag and drop the widget to your area of choice. Use this space to convert site visitors into customers with a promotion.
© Copyright Your Path to Success