We recommend that you base your investing for retirement on a sound financial plan. Here are the four key factors that your plan should address to ensure that your retirement investing generates enough income in retirement:
1.) How much you expect to save prior to retirement;
2.) The return you expect on your savings;
3.) How much of that return you’ll have left after taxes;
4.) How much retirement income you’ll need once you’ve left the workforce.
Stick with conservative estimates to account for unforeseen setbacks
As for the return you expect from investing for retirement, it’s best to aim low. If you invest in bonds, assume you will earn the current yield; don’t assume you can make money trading in bonds.
Over long periods, the total return on a well-diversified portfolio of high-quality stocks runs to as much as 10%, or around 7.5% after inflation. Aim lower in your retirement planning —5% a year, say — to allow for unforeseeable problems and setbacks.
Above all, it’s important to remember that while finances are important, the happiest retirees are those who stay busy. You can do that with travel, golf or sailing. But volunteering, or working part-time at something you enjoy, can work just as well.
One thing we encourage all investors to do is perform a detailed study of how you spend your money now. Then, you analyze your findings to see what personal expenses you can cut or eliminate. This too can have fringe benefits, especially if it helps you break unhealthy habits. You may be surprised at how much you’re spending and how much more you could be saving for retirement.
Dollar-cost averaging brings automatic profits
The best retirement plan you can have is to start saving as early in your working career as possible. You then invest a steady or rising amount of that money in the stock market every year. When you follow this plan, you automatically profit from dollar-cost averaging. You will automatically buy more shares when prices are low, and fewer shares when prices are high.
In retirement, you reverse the process. You live off your dividends, and sell stocks only when you need more money. When you do that, you sell your lower-quality holdings first. That way, your sales have the added advantage of upgrading the quality of your portfolio.
Of course, you can improve your returns and cut risk if you structure your retirement investing around our three-part approach at TSI Network. Invest your money mainly in well-established, dividend-paying companies. Spread your investments out across most if not all of the five main economic sectors (Manufacturing & Industry, Commodities & Resources, the Consumer sector, Finance, and Utilities). Downplay or avoid stocks in the broker/media limelight.
That limelight tends to push up investor expectations to unrealizable levels. When unpleasant surprises come along, they can have a brutal impact on prices of stocks in the broker/media limelight.
A RRIF is a great long-term investing strategy for retirement
Converting your RRSP to a Registered Retirement Income Fund (RRIF) is clearly one of the best of three alternatives at age 71. That’s because RRIFs offer more flexibility and tax savings than annuities (see the pros and cons of annuities on TSI Network) or a lump-sum withdrawal (which in most cases is a poor retirement investing option, since you’ll be taxed on the entire amount in that year as ordinary income.
Like an RRSP, a RRIF can hold a range of investments. You don’t need to sell your RRSP holdings when you convert: you just transfer them to your RRIF.
When you hold a RRIF, you must withdraw a minimum each year and report that amount for tax purposes. (You may withdraw amounts above the minimum at any time.) Revenue Canada sets your minimum withdrawal for each year according to a schedule that starts at 5.28% of the RRIF’s year-end value at age 71, reaches 6.82% at age 80, and levels off at 20% at age 95.
If you have one or more RRSPs (registered retirement savings plans), you’ll have to wind them up at the end of the year in which you turn 71.
Are you investing for retirement already? If so, what strategies are you using? Share your experience with us in the comments.
Pat McKeough has been one of Canada’s most respected investment advisors for over three decades. He is the founder and senior editor of TSI Network and the founder of Successful Investor Wealth Management. He is also the author of several acclaimed investment books. This article was originally published in 2015 and has been updated. It has been republished on the Hub with permission. You can find the latest version at TSINetwork here.