Risk Aversion May Be Your Biggest Retirement Planning Risk

There have been many studies done that show Canadian investors are highly adverse to risk when it comes to their investment portfolios.  However, what most people don’t realize is that risk aversion can be the biggest risk of all when it comes to retirement planning.

When asked, many believe the way to reduce risk in a portfolio is to invest in GICs, T-bills,  Canada Savings Bonds and high interest savings accounts.  The return may be small, but your money is safe, right?  Wrong.

What most people fail to realize is that these ‘safe’ investments are exposed to long-term ‘Inflation Risk’.   With interest rates at historical lows there is a good chance most if not all of your return; as well as some of your principle; will get eaten up by inflation. 

Simply put; inflation is the cost of everyday items continually going up in price. For example, when I started in this business (almost 20 years ago) a stamp cost $0.29 today that same stamp is now $0.85.

When considering your investment options it is important to look at the long-term purchasing power of your money.  The current rate on a 1 year GIC is 1.3%, therefore if you invested $10,000 your money would grow to $10,130 by year’s end.  The problem; with the current rate of inflation being 1.8%, you would need $10,180 just to maintain the purchasing power of your money. 

Furthermore, if your investment is held outside your RRSP or TFSA your investment gains will be subject to income tax.  With a marginal tax rate of 46% your gain is reduced from $130 to $70.20, putting you even further behind.

As an investor you need to invest in securities that will not only keep up with the rate of inflation, but will grow your assets as well.   Furthermore, the fact that you will probably live longer than previous generations means you will need to save more money by the time you retire; also known as ‘longevity risk’.

 

Determining what kind of return you need to grow your assets sufficiently to fund your retirement is a complicated calculation.  There is a range of variables to consider including; how much have you accumulated thus far?  How much do you need to live on?  And what will be your withdrawal rate?  

There is no question that everyone’s situation is different and your lifestyle goals will determine how much you will need to save.  Hopefully one thing is clear, to avoid running out of money in retirement it might be worth taking on a little more investment risk today. 

If you would like to review your portfolio in relation to your retirement planning don’t hesitate to give me a call, this is my area of specialty and what I love to do.

Have a great weekend,

Tracey

Sources:  Advisor.ca article by staff posted 07-28-14, BBC News, In the 90s.com, Scotiabank