Debunking five retirement myths

Franklin Templeton's Matthew Williams debunks five popular myths around retirement, including spending patterns, asset allocation and longevity risks.

Ruth Saldanha 5 October, 2018 | 5:00PM

Stock investing is like gambling. You need to have a lot of money before you start investing. You can only invest or save for one goal at a time. If everyone is talking about it, I should definitely invest.

These are some common myths about investing that many new or first-time investors fall for. These myths aren't true -- all stock investing is not gambling, investors can start investing with even $50 a month, most investors multi-task and save for multiple goals at the same time, and often hot-tips or trends might not be the best investments at all.

Today, we will examine some more investing myths, this time, around retirement. Many people believe these myths, but they aren't really true.

Myth 1: Your need for money decreases as you move through retirement

The older you get, the less money you'll need to spend. Right? Well, not really.

People often expect to spend more in the active part of their retirement and lower their expenses into a lower-cost lifestyle in later years. The amount a person needs in retirement depends entirely on the lifestyle of choice. For instance, if a person's retirement plan is to retire to a cottage in the country and spend time fishing, chances are expenses will be significantly lower. However, if a person wishes to travel extensively after retirement, income needs could be drastically higher than they were during their working years.

"Really just taking a step back and thinking about the direction of your discretionary expenses, I think that's a really helpful step as you formulate a vision for your retirement spending," says Morningstar's director of personal finance, Christine Benz.

"There are three phases of retirement: active, passive and assisted," says Matthew Williams, senior vice president at Franklin Templeton Investments Canada.

The active stage is when a retiree could have more capital expenditure, maybe for travel, sports, or even to buy a new car; this stage usually lasts for the first 10 years after retirement. The next stage is passive, between 10 and 20 years after retirement, when the retiree spends more time with family, and could see physical ability slow down; expenses tend to drop and be lower in this stage. The final stage is assisted, which could be 20 years after retirement, where expenses related to aging creep in, such as mobility devices, nursing services and others.

"For retirement, we tend to see a U-shaped curve, with a shallow U between active and assisted retirement, where expenses drop," Williams said.

Myth 2: A 20-year retirement is plenty

In late August, a CD Howe study of life expectancy in Canada found that wealthier men and women live longer than their lower-income counterparts. Wealthier men can expect to live up to 83, as compared to lower income males whose life expectancy is 75, while wealthier women can expect to live up to 86, three years longer than women who have lower incomes.

These findings are comparable to the government actuary life tables, that show that a 65-year-old male has a life expectancy of 19.3 years (meaning 84.3 years) while a female of the same age has a life expectancy of another 22.1 years (meaning 87.1 years).

However, both these findings may actually be on the low side.

"The reality is that a significant number of people will live beyond 85 due to many factors, not to mention that medical science and technology is also aiding longer lives," says Williams.

To guard against running out of money, a couple should plan for at least one partner to live to 95, he advises.

Myth 3: You can predict when you'll retire

Almost all working people at least think abut when they would like to retire. Many of us use age 65 as the magic number. However, that might not be when we retire at all.

Morningstar's research shows that workers in the United States usually end up retiring earlier than they plan to. And though delaying retirement is usually the go-to solution to fix a retirement fund that has not yet hit desired size, that may not happen either. The research shows that it is difficult to predict when a specific person will actually retire, and given this uncertainty around retirement age, some investors may need boost their current savings to achieve their retirement targets.

"Using experience as a guide, we see that employees in the public sector like workers in hydro, nursing or teaching have defined benefits, and for these workers, it is easier to predict retirement ages. For private sector employees, retirement is multi-transitional. An investor could go from education, to employment, to part-time work, to volunteering, to charity. There are several stages to retirement, and the three-stage process of education to work to retirement no longer holds true," Williams says.

Myth 4: The '100 minus Age' asset allocation myth

One of the old rules of thumb states that the percentage of exposure an investor has to stocks should be 100 minus the investor's age. For example, a 68-year-old would limit her portfolio to a 32% weight in stocks.

"With people retiring earlier and living longer than ever before, this myth is dangerous," says Williams, adding that most retirees need 70% or more in stocks.

Williams suggests a bucketing system for retirement portfolio planning. Each retiree is unique and should build buckets based on individual circumstances. Having said that, at least three buckets could be a part of a retirement portfolio. First, a consumption bucket, that has five years of annual income in it. The funds in this bucket should be invested in cash, short-duration bonds or inflation-linked bonds. The second bucket is the longevity bucket, that should hold 15 years of income. A chunk of this bucket could be invested in stocks, depending on the risk profile of the retiree. It is also important to hold some inflation-linked bonds in this bucket. The last bucket is the inter-generational bucket, that would hold whatever is left after the first two buckets are full. This bucket would usually have a longer holding period of 20 years, so could hold equity or real estate assets, Williams says.

Myth 5: Retirement planning is easy

When it comes to retirement, the DIY approach could be dangerous, Williams says. There are a multitude of products and accounts to choose from, and as the stages of retirement unfold, it is important for retirees to get advice to ensure that their money is working for them.

Another important factor is tax saving. Retirees might not be aware of how to withdraw or drawdown investments in the most efficient way, while saving tax, and also building out an income stream, Williams notes.

About Author

Ruth Saldanha  Ruth Saldanha is Senior Editor at Morningstar.ca