Fund Investing

What to consider before taking the retirement plunge
By Diana Cawfield | 07/05/13

The retirement years might be golden for some individuals, but expectations and reality may differ, says U.S. investment and retirement consultant Michael Falk.

About the Author
Diana Cawfield is an award-winning writer who has been a regular Morningstar contributor since 2000. Her numerous publication credits include the Toronto Star, Advisor's Edge and Chatelaine, as well as the Canadian Securities Institute's online educational services.

"My attitude on retirement is it's a golden ticket to give you a life that you want but you don't have," says Falk, who will be one of the speakers at the Morningstar Investment Conference in Toronto on June 5. But, he adds, just because there are better things in life doesn't mean that you'll be able to experience them.

"Never before in the history of mankind have older people held more productive capacity than they do today," says Falk. Yet inviting people to retire, or paying them to leave the workforce, puts further stress on economic growth on a society. "So I'm not certain that retirement is the best idea," says Falk, a partner with Focus Consulting Group who is based in Riverwoods, Illinois.

Apart from the impact on society, retirement also places additional stress on relationships and has negative implications for self-esteem. Retirees may have more time than they know what to do with. Medical research cited by Falk indicates that inactive people who are not engaged are at increased risk of dementia and having less fulfilling relationships with people, and are prone to depression.

To meet the potential challenges, says Falk, you need to start thinking about what retirement is all about and what it is you're going to be doing. If you don't have hobbies or other activities to keep you busy, "then maybe you ought to work a little longer if you're able."

Along with his consulting work, Falk also teaches as an adjunct professor at DePaul University in its certified financial planner (CFP) certificate program and on behalf of the CFA Society of Chicago. A graduate of the University of Illinois with a bachelor's degree in finance, he also holds the certified retirement counselor (CRC) designation.

Michael Falk

From a financial perspective, determining spending needs and spending desires in retirement is the first step to bridge any income shortfalls. Despite ongoing concerns and commentary about retirees not having enough income to span the years, research indicates that people do find a way to make ends meet.

"Needs might be a hamburger but desire might be a steak," says Falk. "Now, of course, when you're making ends meet, one negative health incident can throw your entire situation in disarray."

To help match spending with needs and desires, Falk likes what the industry calls the bucket method. "Even though propeller heads seem to decry the bucket method, it works really well."

The method involves dividing money into short-term, mid-term and long-term buckets. The money that you know you're going to need in the next two to three years should be kept only in cash or less risky vehicles like short-term bonds.

The money that you're going to need to spend for, say, three to seven to 10 years out, should be invested in a conservative balanced portfolio. For long-term needs beyond 10 years, equity-type investments are recommended.

"It's like a reverse to dollar-cost averaging," says Falk, "but what you do is you have the assets that are more volatile as your longer-term assets and you allow that volatility to not disrupt your near-term needs."

In constructing a portfolio to weather the years, an investor might consider having the balanced or equity portion of longer-term assets a little more biased toward income-producing equities. What surprises many people is that dividends aren't paid only by large companies. "You'll find upwards of 40% of small-cap companies actually pay dividends," says Falk, so they can add to both diversification and yield potential.

If government or pension income falls short and meet perhaps only 75% of your retirement needs, Falk says you should ensure that the money buckets are very carefully constructed. Alternatively, use some of your savings to buy an annuity that will provide a guaranteed stream of income.

When it comes to financial behaviour by investors, Falk cites three common errors of judgment. What really is behind financial literacy, he says, "is the fact that the average person is not really comfortable with math. They don't understand compound interest and the impact of inflation over time."

The first error that jumps out is that investors don't understand what they can afford to spend with the savings they've accumulated. "You give the average 65-year-old a half a million dollars," says Falk, "and they think they've got a ton of money and that they're good to go." In reality, if their lifetime is 20 years longer, that $500,000 is $25,000 or just a little over $2,000 a month, without calculating compound interest and inflation.

A second common error is embarking on retirement when you are still in debt. The issue with debt is that it fundamentally alters your amount of needs versus wants for your budget, "and it doesn't do it in a good way," says Falk.

The third error, perhaps the most important point, is that people don't fully embrace and understand what retirement will be like. According to Falk, retirement affects your life in a way that is not very predictable. For example, in the U.S., the largest growing incidence of divorce is for people who are 60 or older.

Falk says the simple explanation for divorce in this age group is the expression of vows for better or worse, for richer or poorer, but not for lunch. "When you're retired, "it's lunch every single day."

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