Retirement investing is not as simple as starting to invest early and retiring. The switch to retirement is a huge transition.
Retirement is not only a change in daily habits but also in investment strategy. The approach many go through when they start investing is to think of retirement, and that’s correct but also wrong.
It’s correct that you are investing for retirement but don’t need a retirement portfolio yet. You want a wealth-building machine, and once you reach your goals (life and financial), you can focus on retirement investing.
It’s not a typical thought process, so take a minute to consider it. Below are 9 tips organized to help you understand retirement investing. The topics will link all the numbers you need to work through for a solid retirement plan, starting with how much you need.
Remember that you spent decades accumulating wealth, and now is where you plan to use it. It looks like below from a timeline perspective.
Your Annual Retirement Income
A good indication of your annual income in retirement is to take your current expenses minus mortgage and car payments. Exclude anything related to your kids’ education or raising kids depending on their age. That should give you a really good insight into what you may need.
Using the 4% withdrawal rule, assume that income is 4% of your portfolio annually. Say you need $80,000 annually, then you would need $2,000,000. You won’t know how much you need to work for if you cannot estimate your retirement income.
Too many people end up having to move or change their lifestyles because they are not aware of their target retirement portfolio size.
TIP: Itemize your annual spending on a spreadsheet to identify your annual retirement income and review it now and again.
Retirement Income Supplement
Should you rely on the income supplement available? I believe you should expect it, but you should plan without it. Consider it the icing on the cake.
Returning to that previous number you got, the question is whether you should adjust it based on your available income supplement.
Retirement is often years away, so planning for a government supplement that changes based on many factors is complicated. Don’t budget with the supplement in mind, even if your portfolio needs high.
You will have access to two income supplements that you can consider when the time is right; Canada Pension Plan (CPP) and Old Age Security (OAS). CPP will be there, but estimating how much is hard. As for OAS, it depends on many factors.
TIP: I think it’s too far out in time to think about how much you would get, so it’s better to keep it out until you get closer to retirement.
The Best Age To Retire
Answering this question is easy enough, and that should be your guide to investing for retirement.
The best age is the intersection of financial independence and health. Then, it’s your choice to approach retirement as you want. You could keep working if you enjoy it or volunteer. The intersection is the turning point in your life.
Figuring out your retirement number is somewhat easy, but then you must put the plan together. Oftentimes, when an investor approaches this question, there is very little time to correct it, and it’s relatively too late.
TIP: Do what you can to stay healthy, but your financial plan can be forecasted with the right tools. You need your contribution and rate of return, which will outline the time it will take to reach your total wealth.
The Retirement Formula
This diagram has everything you need to retire and validate your numbers above. Simple, isn’t it?
Here is a sample Google Sheet you can use quickly to do the math. (Click the link and make a copy of the Google Sheet to enter your numbers)
Time is a number here, not some nebulous life timeline. Does it match your retirement age after some calculations?
The same goes for the wealth number you need to achieve financial independence. Those are easy numbers to figure out.
The invested amount is how much money you can put aside annually. That’s another number you could probably estimate annually and increase over time.
The final number, your rate of return, is critical. Start small, like 6% or 8%, to see if the numbers work for you.
TIP: This forecasting exercise is important because it establishes your parameters for your investing journey.
The Standard Withdrawal Rate
Don’t plan your retirement with a risky yield. Start with the standard portfolio withdrawal rate and go from there. If you plan to withdraw 4% (dividends or not), the theory is that you won’t outlive your money.
The challenge is forecasting, well, more specifically, risk. As we get older, we also want our money to be safe from a market crash, which creates the risk. The safer you go, the less the 4% rule works.
It’s a balancing art.
TIP: Don’t be your worst enemy. Learn to forecast with a spreadsheet, but you need to know your growth to forecast withdrawal.
Follow The Bucket Strategy
The bucket strategy is putting risk in a box and putting it aside and out of mind.
The concept follows the principle of having one year’s worth of expenses in cash, followed by one year in stable investments, and then you have your equity portfolio.
Executing the bucket strategy isn’t hard, but starting with one year in cash isn’t easy. You either withdraw one year or accumulate it before you retire. Slowly reducing work hours can go a long way toward setting up with a year in cash. Unless you have access to a pension, the first year of your bucket strategy will need some planning.
How many years of safe cash do you want? It depends on your fear of the market. In my limited experience, seeing a market recovery takes at least one year; the safest is 18 months at a minimum.
TIP: Avoid using monthly dividend stocks to pay the bills monthly. That’s the same as living paycheque to paycheque. Also, monthly dividend stocks often switch to quarterly payments or reduce dividends – be careful.
Hope Isn’t A Plan!
Not all situations are perfect, but hope isn’t going to make it happen either.
Sometimes, you need more income, and the 4% withdrawal (or yield) approach doesn’t work out. There are options to boost your dividend income by a couple of percentage points, but it will impact long-term growth.
There are strategies like covered calls where you use options to generate extra income. Some savvy investors do it on their own, but I have found it hard to do options. Instead, you can use covered call ETFs to accomplish the same; just be careful about the structure of the ETF. Read the prospectus to understand if leverage is involved.
TIP: Some high-yield ETFs with leveraged strategies can be risky. Don’t start with them if you need to boost your income. Start slow and take your time.
If It’s Too Good To Be True …
When it looks too good to be true, be sure there is a downside. Do your homework, and don’t rush. Some new ‘Yield Max’ ETFs can feel attractive but there is a risk attached.
Another unique high income investment is split shares have been around for a while and are popular with some income investors but you need to understand how split shares are structured before you invest for the higher income.
TIP: If you are a passive investor, it means you don’t pay attention daily … Some income investment options require you to have an active investor mindset.
Some Light At The End Of The Tunnel
You can adjust your portfolio to have a higher yield while managing risk systematically. That way, you can control the risk while enjoying a higher income.
Tracking your portfolio accordingly with a spreadsheet is critical —a Google Sheet works well in this case.
TIP: Don’t rush to transform your portfolio with a higher yield. Take it one step at a time to get used to the new holdings.
Keeping More Of Your Money
Once you reach the retirement pivotal point, optimizing taxes becomes your most important strategy for your retirement.
If you are careful and strategic, you can earn close to $50K tax-free in dividends. Can you imagine? You get to keep all of it!
Managing your withdrawal across your accounts will be your main juggling act.
TIP: While dividends have their merit in retirement, capital gain is the most efficient tax rate.
The Last Line of Defense
For many, the equity in your home is the majority of your retirement plan. There are many ways to access equity, but it revolves around managing cash flow effectively and making it last.
A reverse mortgage is a product that can help with retirement, but it also means you may not leave any money to your descendants.
TIP: Don’t use the reverse mortgage to just splurge and live the big life unless you know the consequences.