Building a retirement nest egg requires discipline and planning, yet most investors take an ad hoc approach to saving for their retirement. The basic formula for building wealth is really very simple:
Time x Amount x Return = Nest Egg.
Despite its simplicity, few people follow or even know the formula. For the most part people live for the moment; they are more concerned about their daily living expenses, housing, clothes, and lifestyle, which tend to consume most of their budgets. People tend to live the lifestyle that their current income allows. We have also become an instant gratification society. No longer are people saving to purchase what they desire; instead they put it on a payment plan and borrow up to their cash flow limit to acquire the item. Since interest rates are historically low, they justify improving their lifestyles by purchasing bigger, better, or more of what they want. In their minds they can afford the payment. As a result they buy nicer clothes, purchase nicer cars, and acquire bigger homes with all the bells and whistles like granite counter tops, stainless steel appliances, etc.
By the time they realize they need to save for their retirement, usually in the early to mid 40’s, they have lost the most important piece of the formula – the investment time horizon. The compounding effect of regular monthly contributions invested over time is the single most important piece of the formula.
The second most important part is how much they invest regularly over time. By the time people wake up to the stark reality that they need to start saving for retirement, they find themselves deep in debt with most of their monthly income going to current lifestyle and debt repayment. Finding the extra cash to start an investment plan is next to impossible. This is not a pattern reserved for low income households. It is consistently found in households at all income levels. The sad reality is that households with higher incomes have an added advantage over households with lower incomes; if they lived slightly below their income level and started investing early and consistently, they could amass a significant retirement nest egg with little effort.
Conditioned by branch advertising and banks promoting retirement solutions every time they visit, most new investors tend to open their first investment account with their friendly banker. Familiarity brings trust, so it is not uncommon for first time investors to fully trust their banker’s advice to help them choose their first investment plan. Since banks are in the deposit and lending business, the natural recommendation is term deposit retirement plan for funds. Unfortunately, the rates offered on term deposits today are at historical lows. After inflation is taken into consideration, the investor is left with a net negative return on their investment.
This leads to the final component of the formula: the rate of return on the investment needed to achieve the desired retirement goal. By the time most investors realize that they have not saved enough for retirement (usually in their 50’s), they no longer have the time element of the formula working in their favour. Faced with a shorter time frame left to save for retirement, they are left with the amount they can invest and the rate of return they can earn on their investment. Unfortunately, by this stage of their lives many are funding university or college educations for their children. Furthermore, between low interest rates and incomes that have not kept up with inflation over the past decade, many have borrowed against their homes to maintain their lifestyle. As a result, they are deep in debt and cannot find sufficient funds to save in order to meet their retirement goal.
This leaves them with one option: earn as much as possible on the money they have managed to save. Many make the mistake of focusing on the total return and not on the net after tax return. They may be tempted to invest in investments that are out of their comfort zone because they are so focused on total return. They may sabotage their retirement by purchasing aggressive mutual funds or stocks that have an impressive track record, not knowing that the fund or stock is at the top of its current cycle and may be due for a significant correction.
Many Boomers retiring today have followed this path of sabotaging their retirement. Many had taken on significant risk in the tech boom of the late 90’s and suffered major losses to their retirement portfolios. Short on time and having inadequate savings, they chased what they thought was a sure thing and they got burned. Having been burned in the stock market and facing low savings rates on bank deposits and bonds, they turned to real estate. It seemed a sure bet. Prices were rising at an ever-increasing rate, interest rates were coming down, and they were able to purchase more house then they otherwise could have afforded, so many decided their house would become their retirement plan. It is simple – purchase as much house as possible with as large a mortgage as possible (enabled by historically low interest rates), then sell and downsize at retirement, pay off the mortgage, and invest the difference to fund their retirement.
However, there are 9 million Boomers that will be retiring over the next 20 years, many of them thinking the same thing. The leading edge of this wave of Boomers are already retiring with over 50% owing more than 40% on their mortgages. 25% of them still owe over 75% on their mortgages. On top of that, many have very little in retirement savings because they invested so heavily in real estate. Moreover, the natural buyers (the Echo Boomers) are a smaller demographic and are financially unable to purchase the Boomers’ homes. Faced with declining home prices and rising interest rates, many Boomers will find themselves unable to sell their homes.
These Boomers did not plan to fail; they failed to plan. Had they started out early in life and had the good sense to hire a financial planner or an investment advisor who offered financial planning as part of his/her service, they would have had a plan in place to help them achieve their retirement goals. The planner or advisor would apply the simple formula above, starting with the desired goal in mind, and calculate how many years they have to save until their desired retirement date. Then he/she would calculate how much they need to save each month and the required net after tax and inflation rate of return they would need to earn on their investments to achieve their retirement goals. The advisor or planner would then draft a plan laying out the steps they need to take to achieve their goal. As part of their ongoing service, they would regularly monitor the plan and make adjustments necessary to ensure their retirement goal is achieved.
For Boomers that have ignored the formula or have managed to make some or all of the mistakes discussed above, there is still hope for them. There is a silver lining, Boomers homes have doubled or even tripled in some markets in the past decade. This is a historic windfall for these Boomers even for those with 40% left owning on their mortgages. They still have significant equity in their current home.
Boomers in major metropolitan markets like Vancouver or Toronto have the most to benefit. There are many communities outside of Vancouver or Toronto where home prices are 1/3 of what they are in Vancouver or Toronto. Boomers should consider downsizing to a smaller home, town house or condo in one of the suburban communities that offer significantly less expensive housing and in many cases a more relaxed lifestyle. They should also consider renting for a few years while the housing market cools off and then buy back in once prices level off. These lofty home prices in Vancouver and Toronto will not remain elevated as many Boomers with significant mortgages rush to sell their homes to downsize and pay off their mortgages.
Retiring Boomers should consider investing their net proceeds from downsizing their homes and paying off their mortgages into a professionally managed portfolio that has been designed around their own unique needs, based on their comfort zone and income requirements. A well-constructed portfolio that is globally diversified, and tax optimized should offer above average market returns with reduced volatility, enabling the investor to take on more risk to achieve the return needed to fund their retirement.
With global equity markets at historic lows, selling overpriced real estate at the top, to purchase historically inexpensive stocks is just common sense. Sell high and buy low is another simple investment strategy that few investors practice. Investors tend to buy high and sell low, that’s just human nature. That is why they need to hire a financial planner or full service investment advisor who is capable of constructing a custom portfolio around the investor’s unique needs as well as counsel them in tough markets to prevent them from making mistakes that will harm their retirement. In addition, Boomers should have their financial planner or investment advisor prepare a comprehensive wealth plan to optimize their family wealth through tax and estate planning.
- By Adrian Spitters, FSCI, CFP, FMA
Adrian Spitters is an avid writer and blogger who recognizes the need to publish on issues relating to the retiring boomer, by offering information and insight to help them transition into retirement and create sustainable multi-generational family wealth. As a Certified Financial Planner (CFP), Adrian Spitters offers financial advice that focus on investments, retirement, business succession, estate and tax planning in cooperation with his client’s own legal and accounting professionals. Adrian offers comprehensive wealth management solutions in the Fraser Valley communities of Abbotsford, Langley, Surrey, and White Rock BC. He has extensive business experience that includes over two decades of helping individuals, business owners, farmers, professionals, and high-net worth families chart a path to achieve their lifetime goals. He is a Senior Financial Planner with Assante Capital Management Ltd. For further information please visit http://www.assante.com/advisors/aspitters/