it pays to be paranoid
Retirement planning means expecting things to go wrong
Say you are 30 and you feel it’s time to think about retirement in three decades. There is a lot unpredictable about those 30 years.
You could have children. Your parents could need financial help. A business or a career can flop.
Yogi Berra, the great New York Yankees catcher and manager, gets credit for saying, “Making predictions is hard, especially about the future.” If only he had tried planning a retirement.
What can go wrong is more than just the details of one’s personal life. Inflation could take off, as it did in the early 1980s when prices rose at double-digit rates. Fixedincome investments like bonds were devastated, for no one would pay much for an old bond with a 5% coupon when savings accounts at banks and trust companies paid two or three times that rate. Inflation’s long-term average since the end of the Second World War is about 3%, but that’s with a lot of variation.
In 2008 there was a whiff of deflation in the air. Major stock market averages around the world lost half their value. Short-term government bonds that were seen as having no risk at all were snapped up until, in the case of 30-day U.S. treasury bills, buyers sometimes paid more than they got back.
Today it’s the European debt crisis. Sovereign bonds of Italy, Spain, Portugal and, of course, Greece — all payable in euros — swoon in value as investors, terrified of losses, flee to U.S. treasuries that offer returns measured in fractions of 1%.
So in trying to create a retirement plan that will be goof-proof, it pays to be a little paranoid, says Benoit Poliquin, chief investment officer of Exponent Investment Management Inc. in Ottawa. “Paranoia pays because it is the opposite of overconfidence.”
He says there are two structural levels in any retirement plan: estimating your own life expectancy and that of a spouse and coping with inflation and market risk.
“If you are budgeting for life expectancies, the odds of at least one person living longer than expected goes up and that certainly increases the total cost of future living,”
You will have more time to spend money and you should assume that you will have a long time to do it
— Caroline nalbantoglu , head of Cnal finanCial Planning
says Mr. Poliquin. “Inflation is correlated, for if someone lives longer, there will be more exposure to inflation.”
As a planning exercise, lifespan estimation is easier the older you are.
At age 70, age 90 is a reasonable horizon. At age 30, it could be much more, for life expectancies have increased remarkably over the past century. For example, according to Statistics Canada, a man born in 1922 could expect to live to 59, a woman to 61.
A male born in Canada 80 years later in 2002 can expect to live to 77, a female to 82. A 30-year-old can expect to live to 72 or 79, depending on gender.
So in the absence of knowing where markets and interest rates will be, it is essential to diversify. Consider life insurance, especially if you are under 30 and in good health. And never be too optimistic about your assumptions.
You can estimate future inflation at 3%, which is a historic average, but there are no guarantees.
And never assume your expenses will go down in retirement, warns Caroline Nalbantoglu , head of Cnal Financial Planning in Montreal. “You will have more time to spend money and you should assume that you will have a long time to do it.”