It’s a bit of a conundrum. After decades of building wealth, you finally enter retirement—but now you have to use the savings you’ve carefully built to fund your lifestyle. The critical question for retirees then is—will they outlive their money or will their money outlive them?

Transitioning from saving to spending can be a challenge that can lead to stress and anxiety. Fortunately, there are proven strategies that can help make the transition smoother, so you can spend your wealth comfortably. 

Many people live relatively modest lifestyles for decades in order to accumulate wealth. Frequently, one of two things happens: either they feel uncomfortable about spending or they get a little too comfortable and run the risk of depleting their retirement assets.

Why is feeling uncomfortable about spending in retirement a problem?

For those whose primary goal is to leave as large an estate as possible to their children, it isn’t. But many people don’t have that mindset. For those who have other dreams for their retirement and have amassed sufficient wealth to make those dreams a reality, feeling anxious about spending their investment capital is a real issue.

Planning for success in retirement

There are a few uncertainties every retiree faces:

1. How long am I going to live?
2. What returns am I going to get for the next 20-30 years out of my investments? What will inflation look like?
3. How might my expenses change over the course of my retirement?

While no one can answer these questions with absolute certainty, we can make reasonable assumptions based on experience and trends.

For example, through research on spending patterns, the average retiree follows a U-shaped spending path. People tend to spend more in the early years when they’re healthy and active on things like travel, hobbies and grandchildren. As they get older spending tends to decrease until health-related expenses lead it to climb again.

The big central question is: am I going to be okay? To answer that, it’s important to start planning as early as possible and to revisit it often. This will allow you to make mid-course corrections. Once in retirement, retirees should continue to revisit their plan to help them stay in control of their money and feel comfortable with the amount they are spending. A financial advisor can help you every step of the way from starting your plan to revisiting it with you in retirement. 

A good starting point in the planning process to help plan for retirement spending is a budgeting exercise. Using a template, determine the minimum monthly cost of living a basic lifestyle—fixed expenses or needs. Ideally, if these expenses were covered by government related benefits such as the Canada Pension Plan (CPP) and Old Age Security (OAS), it would allow retirees to feel more comfortable with spending their savings. After that, look at individual lifestyle expenses, or wants, such as travel, hobbies and helping family members. Added together, these expenses will provide a sense of how much the desired lifestyle is going to cost in retirement.

After accounting for their available sources of income in retirement (government benefits, pension plans, rental income, etc.) one can determine how much cash flow their portfolio will be required to generate.

Why does the sequence of return and risk matter?

Retirement may also mean that you need to do some planning around portfolio withdrawals. 

When people are in the accumulation phase of their lives, the sequence of investment returns isn’t as important. For example, say you invest $1 million when you’re 40 and over the next 20 years you average six per cent return per year every year (not realistic but assumed for this exercise). The end result isn’t much different than if you had averaged 12 per cent per year over the first 10 years and zero per year over the last 10 years, or vice versa. In either scenario, the average yearly return over 20 years was six per cent. 

But once you enter the decumulation stage of retirement, that all changes and the sequence of returns becomes critical because you’re now withdrawing from your portfolio.

Going back to the previous scenario and using an extreme example to help conceptualize the sequence of return risk, assume you expect to earn six per cent per year on average over the next 20 years, but you get zero per cent for the first 10 years and 12 per cent per year over the last 10 years while also withdrawing six per cent per year from your portfolio. In 10 years, you’ll have reduced your capital by 60 per cent. In this case, getting great returns over the next 10 years won’t be of as much use because the capital has been greatly reduced.

For a more realistic example, consider the outcome of someone retiring at the beginning of 2008 at the onset of the great financial crisis versus the outcome of someone retiring at the beginning of March 2009, the bottom of the bear market. How might their retirement nest egg look after their first year of withdrawals?

Extra Cash

If retirement is getting close but you’re worried about drawing down on your capital when investment values might also be declining, having cash or an equivalent on hand can help alleviate the anxiety and may also increase the longevity of your portfolio.

Setting aside about two years of living expenses in cash should allow you to ride out most periods of declining markets, as most bear markets tend to last about a year. This means you won’t be forced to sell investments when they might be down 10-20 percent or more, which can be very reassuring and may better help you ‘stay the course’ with your long-term investment strategy.

One strategy that may no longer be as useful is drastically reducing equity exposure as you get closer to retirement. Decades ago, with life expectancy much shorter, this strategy might have worked, but with the average joint life expectancy for a couple being around 90 today, clients may be looking at a 25- or 30-year retirement.

Ultimately, it should come down to an investor’s ability, willingness and need to take risk, but it’s worth considering that it may require taking a little more risk when nearing retirement than one might have in the past.

Whether you’re uncomfortable with the idea of spending your savings or you’re spending too much and at risk of running out of money, properly assessing your goals can help. By taking a realistic look at your situation, including your finances – needs and wants – and implementing proven strategies, you can make the transition from accumulation to decumulation feeling confident about the future.

Original content written by Curtis Huska, Director and Investment Counselor, ATB Wealth, ATB Investment Management Inc.