Will We Have To Moderate Our Retirement Expectations?
David Christianson, CFP, R.F.P., TEP
Most Canadians who are within 10 to 20 years of retirement have lived through some very positive economic times. The baby boom generation has matured (if I can use that term loosely) in a benign atmosphere of low inflation, declining interest rates and generally good stock market returns.
In the 1970s, double-digit inflation was rampant and eating away at the purchasing power of incomes and investment returns. Since then, inflation has averaged less than 3%.
When Boomer demand for mortgages added to the high inflation atmosphere, borrowing costs peaked out at over 21% in 1981. However, rates have generally declined ever since (with notable upticks in 1994 and 2005), making it easy to borrow for larger houses or other lifestyle indulgences.
As interest rates fell, bond investments did very well, averaging 8% after inflation. The stock market, while providing a number of memorable corrections, has also produced returns averaging about 8% per year after inflation. (On the other hand, from 1968 to 1980, the real returns were more like 1% per year on stocks, and the 10% to 15% gross rates on bonds and GICs were largely eliminated by inflation and taxes.)
The icing on the cake appeared to be the enormous increase in home and vacation property values over the last 10 years. The only negative there is that affluent boomers who waited too long to buy the cottage or ski chalet had to borrow more money to do that. But, what the heck? Interest rates were low and they could afford the payments.
Over the same period, financial planners and the popular press have encouraged people to plan a retirement based on having some 70% of pre-retirement income to spend. When you deduct the cost of going to work, calculate lower tax rates and hopefully lower debt service costs, that means the same standard of living after retirement as when working. That’s a pretty good deal.
But will that really come to pass? Or should we start adjusting our expectations? (To avoid panic, keep in mind that many people retire happily on 50% of their previous incomes and still do everything they want to do.)
These questions are not being asked in the context of the recent market correction. Although brutal, and with the possibility of an extended bear market, we are really talking here about longer-term trends.
The market will recover, as it always does, but we need to look forward to the next 10 or 20 years. What will they hold in store?
Recently, inflation has become a real threat again. One silver lining of the recent market correction is that it has been caused in large part by the collapse of commodity prices. By definition, these dropping prices are easing those inflationary pressures, starting with energy prices, building materials and food.
But we are still faced with low interest rates, which mean a low return on guaranteed savings. Stock market returns could easily average 8% going forward from the current low point, but we've got a lot of catching up to do after the last 14 months of declines.
So what does all this mean for you? Step one is always to know where you stand financially, by adding up your assets and liabilities and projecting your situation into the future. For the sake of discussion, let's assume you and your financial planner have done that, and you have a clear picture of what your retirement will look like, assuming 4% returns (after inflation) continue. That is still a reasonable assumption, and a good starting point.
Now, look at the effect if your net rate of return is lower, either because of lower investment returns or higher inflation. Are you still able to spend the amounts you project you will need?
What type of spending is optional and what can be cut out? Have you slipped into the habit of being self-indulgent and denying yourself nothing? Many of us have, and probably need to go through a frugality exercise for a few months or a year. Even with that, we would still be living better than any generation in history.
The irony is that people I know who get by on much lower incomes, through some creativity and inventiveness, seem to be a lot happier than those who spend without restraint and ‘satisfy’ their every whim.
It's something to think about and try on for size, before circumstances force it on you.
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This article originally appeared in the Winnipeg Free Press on Friday, September 12, 2008.
David Christianson is a fee-only financial planner and investment counsel with Wellington West Total Wealth Management Inc. His column, ‘Dollars & Sense’ appears Fridays in the Winnipeg Free Press.