When you’ve worked, budgeted and saved for 20, 30, 40 or more years, it’s really hard to look at your life savings and think “I should take a gamble with that money!” After all, your retirement nest egg is meant to carry your family, financially, through the next several decades. As a result, safety is top of mind when it comes to how most Manitobans want to manage that money. That’s why it may surprise you when I say, “being too safe with your retirement money could be the riskiest thing you do.”
How could “playing it safe” be potentially risky? The answer to that lies in one single word, “inflation.” The cost of all things we buy tends to increase over time. Utilities, groceries, dinners at restaurants, electronics – you name it – life gets more expensive each year. The Bank of Canada, who controls monetary policy, has a target inflation rate of between 1-3% per year, ideally hitting the mid-way point of 2%.
How then, does inflation affect your retirement? Inflation means that the cost of living your retirement can reasonably be estimated to go up by 2% per year. Compound that out over a 30-year retirement period and a $100 grocery store bill when you’re 60 will cost $181 by the time you turn 90! Put another way, every dollar you own today will be worth $0.55 of purchasing power 30 years in the future, if it never grows. For your retirement nest egg to stay above water – ignoring taxes and withdrawals – it needs to generate a minimum return = inflation.
The long-term pressure of inflation on retirement is the main reason why I’m shocked when I encounter clients who have most (or all) of their retirement savings in ultra-low risk, ultra-low reward investment vehicles. If your retirement funds are in a hypothetical account that earns 1% per year, but inflation is 2% per year, you’ve effectively guaranteed your money is losing 1% instead! Since we don’t see the cost of inflation on our investment statements, it can be easy to trick yourself into thinking you’ve played it safe and come out ahead on the year, only to find yourself woefully short on retirement funds down the road as you need larger withdrawals to keep up with everyday expenses. That’s a substantial risk of inflation eroding your retirement capital!
While I do educate clients on the inherent risk of overly conservative retirement plans, I want to make it clear I don’t advocate an extreme risk profile for retirees either. While investment returns are not guaranteed, I do think there is a smart, manageable middle ground to be achieved, based on your personal investment profile and comfort with risk. A place where some well-diversified risk can be introduced to help (potentially) achieve reasonable rewards that may to outpace inflation over the long-term. By carefully managing when, where and how this portfolio risk is achieved, you can have confidence that your nest egg will remain intact for decades to come!
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