Help your clients get back to planning basics

(October 2008) Everyone knows that market volatility and retirement preparation can make for an unhappy combination. It’s bad for the advisor, but even worse for clients. However, the unfortunate fact is that we are in a period of extreme market volatility, and no one knows exactly how long it will last.

When markets are as volatile as they are, it is very easy to lose perspective. None of us can control markets, but there are many things connected to your client’s financial well-being in retirement that can be controlled. It is times like these that it is most important to go back to the basics.

Analyze and plan expenses

When we talk retirement planning at Fidelity, we first talk about expenses. The first step is for clients to separate their essential expenses from their discretionary expenses. This is a client-centric process. While some expenses fit clearly into one category or the other — food, clothing and shelter, for example, are obviously essential expenses — the division is murkier than you might think. What is essential for one client may be discretionary for another and vice versa.

For clients who haven’t done this before, the place to start is their current expenses. Almost every client is surprised by where they actually spend their money. Some clients will respond that it is difficult, or impossible, to project expenses in retirement. Most people think their lifestyle will be very different from what it is now. And it very well may be. This discussion presents the perfect opportunity to introduce — or reintroduce — the concept of envisioning what retirement will actually be like.

This is difficult for many clients. They know that they will stop working; they know that they will have more leisure time; they probably have a vision of playing more golf or spending more time on a hobby. But this doesn’t mean they’re envisioning retirement. It may be useful for some clients to “fake” retirement for a couple of weeks or a month so they can see just what their post-working life will be like.

Some clients resist tracking expenses because they don’t want to know where their money goes. The usual reason for this is that they suspect they will have to cut back and don’t want to face that reality. As advisors know, knowledge is always superior to ignorance. Some clients may discover that their spending needs trimming — or, as I’ll discuss later in this article, that they may need to look for additional sources of income. But if they don’t have the basic facts about where their money is going, they can’t do anything about it.

Know where other sources of retirement income are coming from

Before looking at the prospective income from their portfolio, clients should determine all of their possible sources of retirement income. This is a simple idea, but many clients really have no idea how much they may receive in Old Age Security (OAS) benefits or to what extent those may be clawed back by the government. They often ignore the periodic notices from the Canada Pension Plan (CPP) as to what CPP benefits will be at a specific age. Since CPP benefits are intended to replace approximately 40% of the average industrial wage in Canada, the role of CPP benefits shouldn’t be ignored. As well, OAS and CPP represent guaranteed sources of income, something that is especially important when income from portfolios may be affected by market volatility.

The next step is to examine potential income from a company pension plan. I have talked to numerous clients who have no idea whether their company pension plan is defined benefit or defined contribution. It can make a big difference in planning for retirement. Going a little deeper, is the client contributing as much as possible to the plan? If not, employer contributions to the client’s defined contribution plan may be left on the table. If the client is in a defined contribution plan, has he or she given thought to an appropriate inflation-adjusted annual withdrawal rate? If not, start with Fidelity’s benchmark, which is 4% per year, adjusted for inflation.

Examine the portfolio

At this point, it is time for you and the client to examine his or her portfolio. Hopefully, this isn’t the first time you’re doing this. Ideally, the advisor will have had several discussions and engaged in careful planning with the client. In volatile market conditions, some changes to investment philosophy may be in order, but hopefully nothing too drastic.

But if the client is reacting very badly to the market downturns, this might be the time to make a significant move. Before making any major changes, however, advisors should take this opportunity to make use of behavioural finance tools to help the client see beyond short-term volatility to long-term investment success.

One tool that is helpful is Fidelity’s volatility website. By going to www.fidelity.ca/volatility, clients can see how markets have recovered from past corrections, the value of staying invested and the value of good stock-picking. Obviously, any conversation with clients needs to include topics such as risk tolerance and timeline.

Working in retirement

If the previous three exercises don’t reassure clients about their financial situation in retirement, they may want to think about working in retirement. At Fidelity, we have had long discussions about the possibility that retirees will need to keep working. It’s not a reaction to market volatility but, rather, acknowledgment of the substantial long-term demand for older workers as Canada’s population ages. Still, the last time the stock market turned down, working in retirement increased; the same may well happen this time.

The major issue for clients thinking about working in retirement is not whether there will be a job — there almost certainly will — but whether they will have the right attitude to stay in the workforce beyond the date of exit they’d originally planned. For a client who has been looking forward to retirement, the idea of working longer may not be attractive. And yet, many of the people who are now working in retirement are doing it by choice because they value the routine, the social interaction with other workers or the satisfaction of the job. People who decide to work longer will have plenty of company — this trend has been going on for several years.

For clients who have defined benefit pensions, the new rules may apply. That is, they may be able to continue to work part-time for their employer, take partial pension benefits and continue to accrue pension benefits. Well worth looking into.

Another positive aspect about working in retirement is that there is choice. For many clients, it will not be necessary to earn as much as they did in their career. It may be a chance to try something they’ve always wanted to try or to take a job with less stress and responsibility.

None of the above is intended to gloss over the reality that some clients face substantially changed circumstances as a result of market volatility, but I hope these remarks have reminded advisors that there are ways of coping, and clients may be pleasantly surprised at the results.

Peter Drake is vice-president, retirement & economic research, for Fidelity Investments Canada. With over 35 years of experience as an economist, he leads Fidelity’s research efforts in examining retirement in Canada today. He can be reached at peter.drake@fmr.com.

Peter Drake