UNLOCK Financial Freedom: 3 Pillars of a Successful Savings Plan - Wise Wealth Podcast ep. 11

Welcome back to another video. In this video we're going to be focusing on what we like to call the three pillars of a successful savings plan. And in a lot of our videos we're focusing on people who are five years, three years out from retirement. So we thought it would be good to outline some of the things that people who are 20, 30 years out from retirement should be thinking about to set themselves up for success. All right, so to set the scene a little bit, the three pillars of a successful saving plan are firstly the contribution rate of the saver, the accumulation period or time horizon between when a person starts saving and when they plan on using the money or retiring, and lastly their investment choice. So with that in mind, the first question that I have for you Sean is what is longevity risk and why is it concerning for retirement planning? Well, you know, longevity risk, as the word longevity implies, it's the risk of outliving your capital. So if you've got a long life, what that also means is you have to cope with the long-term effects of inflationary pressures and taxes. And the longer you live, potentially the more capital you need to save by the time you reach retirement. So it's a real risk and that risk gets compounded to the effect that maybe you don't get around to saving as early as you should have or maybe you're not saving as much and you try to play catch-up to make up for lost ground. So, you know, people are living longer in general and so we need to take it seriously and it's a risk that often people don't think too much about and all of a sudden before they know it, they're on the cusp of retirement and they've lost some ground because they didn't take advantage of the compounding that the years could have provided for them. So with using the three pillars I've mentioned before, so contribution rate, accumulation period, and investment choice, firstly, what are those and how do those relate to longevity risk? Yeah, contribution rate, at one level it should be customized. I mean, we're drawing from a study that Manulife had put together and looked at some research. One of the things they found about contribution rate is that if somebody was contributing, let's say, 5% of their payroll to a match plan, that often, based on their calculations, was leading to shortfalls and their optimized savings rates to increase the probability that someone would reach their goals from a retirement standpoint and longevity standpoint was upwards of 15%. So that's a lot higher than what a lot of people are doing. And the second thing that they found when it came to, you know, that whole area's accumulation period, again, there's a huge, huge difference between someone maybe in their mid to late 20s who starts consistent saving to someone who maybe deferred a decade and didn't get going until their mid 30s to late 30s. And the cost is really, really significant. And so to the extent that you defer by a decade, that exponentially increases the chance that you're not going to fund your retirement sufficiently. And then investment choice is another area which will impact today in this discussion. What people don't realize is that they're often way too conservative with their investment choices. And you can see it in the data. A lot of people default to money market accounts and GICs, high yield savings accounts, as a preferred option for investing. They don't like the stock market. It kind of makes them feel uncomfortable. And yet the reality is, as they become hopefully students of investing, one of the safest places you can invest is in the stock market. In the short term, it can be risky, but in the long term, it's one of the best investment choices you could make when it comes to the long-term compounding of your retirement account. So those three areas you need to keep in mind when you're trying to get ready for retirement, for sure. Yeah, I love the way that, I'm stealing this from Ben Felix, but the way he talks about your accumulation period or your time horizon. So I'm going to make the argument here. I'm not going to say it as eloquently as he does, but if we have a long enough time horizon, so 20, 30 years, and if we define risk as volatility, we can think of stocks as effectively risk-free assets. So over the longer term, horizons, volatility decreases and stocks converge after going up and down for many years, converge around historical averages, which we can say 67% for stocks. So obviously there's huge assumptions baked in there. There's other risks like sequence of return risk and behavioral risks and valuation risks. But normally when people talk about risks, they're talking about volatility. And so when you have 30 years, it really does make the most sense to throw majority of your money, assuming it's not going to be too difficult for you to swallow that volatility, but throw most of your money in stocks. I never thought about that, especially in school, how when you have a long time horizon like that, you don't really have to worry about the volatility in the middle of it. So next question I have for you is why is starting to save for retirement early so important and what impact does delaying savings have on your accumulation? You know, I think that probably one of the most important concepts we'll talk about is just time and compounding of the value of your investment accounts. So I think many people know this somewhat intuitively, but I think if you take a calculator or you go to our website, we've got some calculators to look at different savings and accumulation rates based on assumptions that people can use, and it's always shocking to see the differences. So you can have, let's say, someone in their 20s that starts saving right away, and then you have somebody else who doesn't start, like I said, until 10 years later. And what you see happen is that the person that saves 10 years later, even if they cumulatively saved the same amount, so in other words they increase their contribution rates in their savings program to have saved exactly the same amount as the person that had saved 10 years earlier, that it could still result in a 47% less cumulative growth in their accounts. In other words, it's not just about the savings you put aside in total, it's about the compounding periods that you have available to you for your savings. So it's really, really hard to make up for lost saving periods, and as a result, from an educational standpoint, it's really important to sort of instill that in people's minds. And so if you're watching this and you're already close to retirement, the takeaway is make sure that your kids or the younger employees that you work with, that you reinforce the fact that this is really critical, you need to start early, because it's really difficult to make up for lost ground later on. And so it's just something you need to reinforce and try to find that balance between, you know, getting that savings plan going and not making other priorities sort of take precedent. So I'll give you one quick example. Josh, you and I met with a couple recently, and fairly recently married, and we walked them through a retirement planning analysis, and I said to them, you don't necessarily need to fully maximize on your RRSP contribution opportunities, you're making decent income as a couple. But what we're going to do for you is we're going to take a look at your current after-tax income, and then work backwards, you're currently in your, you know, your late 20s, you're not returning for a few decades, let's calculate what you need to save starting now to reach your retirement income goals, to have enough money in the pot to do that. And when you start early, it doesn't have to be a crazy dollar amount. And so we went through that analysis, and they looked at us, and they say, Josh, and said, yeah, that's super doable. So I think that if you're in a situation where you don't have a pension plan, or you're just thinking, well, what should I do? If you start early, it doesn't have to be a really big budget stretch. But if you defer it, then it becomes a big budget stretch, and you've lost that compounding effect that I talked about. Yeah, I would really encourage if anyone's watching this, and they're not really familiar with how compounding works, just look up a video online. There's so many good videos explaining why the math of compounding is so crazy, and why the graph just is so beautiful when you have a time horizon of 30 years. So yeah, I'd really encourage you to do that. The next question I have for you is, how does investment choice, so the third pillar of a good savings plan, impact retirement readiness? And why is an overly conservative portfolio potentially detrimental when you're young? Really great question. And I think that the way to answer that question is, I'm going to show something on the screen to illustrate the point. So let's take a look at that together here. So this slide is a really good example of what we're getting at. And so it's a slide that summarizes a few different investment options, Josh. So you can see, it's over a 20-year period from 2003 right through to 2023 as an example. And what we have is the average one-year GIC rate, three-year GIC rates, the Canadian aggregate fixed income returns, so an aggregate bond portfolio, and the Canadian stocks, comparing stocks to bonds to GICs over this 20-year period. And what you see is that basically the GICs went from 100,000 initial investment to 128,000. The three-year GICs grew to 140,000. So 28 and 40% increases for those two asset classes. The bond portfolio doubled, went from 100,000 to 206,000. And then we saw growth in the Canadian stock market of almost half a million dollars. So that $100,000 grew to half a million. So it's a massive, massive difference between the various investment categories. Now, if you're 10, 15, 20 years away from your retirement date, you want to be in this dark blue. This is 100% equities. Yes, there's volatility. There's periods when the market's not doing well. But cumulatively, that is going to give you above average performance to help you cope with inflationary pressure and really grow your portfolio. Now, as you get closer to retirement, you definitely want to de-risk. And that's why we have this box here. So 50% Canadian stocks, 30% bonds, 20% GICs. You've made your capital. You've grown your portfolio. And probably two to three years away from retirement, you want to begin de-risking and becoming a little more conservative. But this is what you're walking away from in terms of the opportunity cost of being too cautious. And the reality is people are too cautious. And they're often even too cautious in the retirement. If you retire and you're 55 or 60 or even 65, there's a part of your portfolio that you will not need for another decade. You do not want to be putting that part of your portfolio in GICs or savings accounts. And yet we see a high percentage of investors doing that when they retire. So you don't want to walk away from this. It's a very important principle. As time goes on, these investments actually become less risky. You have a higher percentage of hitting your return objectives and your asset accumulation objectives for retirement than by sticking the money in a GIC. Yes, safe in the short term, but you rob yourself of a huge amount of purchasing power and income by parking it in GICs. Yeah, I think that slide's really good. Because you also have to factor in inflation. And what a lot of people don't understand is the return they should care about is the real rate of return, which subtracts out inflation. So if you earn 5%, for example, when inflation is 3%, your real rate of return is only 2%. And so you really need to think about that when deciding what investments you choose. That was really good. So another question that I have here, what are some of the key statistics that highlight the challenges people face in achieving retirement readiness? So we've talked about some of them already. Now, the unfortunate thing is life is not fair. And when we looked at the study, it did identify that there are some inherent biases between different groups. And one bias is for women. This is changing, but the reality is women, historically, didn't work as long in the workforce. They were in another workforce. As a result, their income was often lower, not because hourly wages or salaries were lower, but they had a back and forth in terms of being in the workforce, which penalized them. Now, that's beginning to change, for sure. But the other issue relates to longevity and life expectancy differences. So for women, particularly, and in a couple situation, often they'll be the last person standing in the relationship. And so the money has to last that much longer. Often, women may take more of a passive role to the investment planning area. This is changing, for sure. And as time goes on, they're going to be more and more intentional. And what's interesting is, and this is in the data, women in general are more successful and better investors. And there's a lot of reasons for that, but there's a natural inclination by many men to take a little bit of a gunslinger approach to their investing style. They tend to be more aggressive. They tend to be more apt to trade and change their portfolios too frequently. And they'll often get in the way of getting performance, whereas women tend to be more disciplined, more consistent, more able to follow a plan and to keep that plan going. And as a result, they tend to have better long-term performance in their portfolios. They just are wired to be better investors in general. There was an interesting study as well, Manulife looked at the United States, and they found that with people with basic social security benefits, that they needed to have, to kind of replace their standard of living, needed to have in the range of about $600,000 of savings in addition to social security to maintain their standard of living. Workers in that 55 to 64 demographic that they were studying though, only had on average about $15,000. So there's a huge disconnect between what people needed and what they actually did. So there's, you know, biases, both societally, demographics, sex, and opportunity. In saying all that, everyone should be a self-initiator and take the necessary steps. Start a savings plan, start early, use equities for the long-term part of your portfolio to maximize your growth. I took a behavioral finance class in school, and we had a speaker that came in and talked about this phenomenon of women having better returns than men in aggregate. And you go, oh, why is that, right? But it really makes sense. When the market's down, the women would come in and talk to the advisor, and the advisor would usually say, don't do anything. They'll come back, right? And the women would be like, okay, that's good with me. And they'd stick to their plan and outperform men who would come in and be like, no, I want this change, I want that change, I want to sell here, I want to buy there. And over time, we see in the literature, the more you trade on average, the worse you do. So it really just speaks to passive, but anyways. Well, that's a really good point. You know, investing is one of those weird areas in every other area of life. Active, you know, doing stuff, fixing things, really rolling up our sleeves and working on the problem is the way to get things done and to fix stuff. But investing, ironically, it's the opposite. If you start mucking around, particularly when the markets aren't doing well, you often will hurt your performance. And it's so counterintuitive because we want to fix it, yet we end up doing things that get in the way of performance. Yeah, but the problem there is that you're assuming that you know what the problem is and that you know what a theoretical solution would be. And that's a good point. And those just aren't true for most people. So the next question I have here, what role do plan sponsors and financial professionals play in helping individuals address longevity and shortfall risk? So I'll start with advisors. I think advisors play a really critical role from an education standpoint. And that's trying to help people cut through all the noise and, you know, the click-baity headlines that grab people's attention and help people focus on core principles for successful investing. So that's an educational process. And the other piece is, I think advisors can play a really important role in keeping clients invested and disciplined. And sometimes that involves offering encouragement or accountability, right? So we're all human beings. We get busy and we don't always do the things that we should do. And so I think advisor in a coaching context helps people to do the things that they should do. So that increases the probability of success. So I know that many people out there might think that, you know, hiring an advisor, working with an advisor, there may be costs or fees for that, that's going to be a drag on performance, I can go it alone. But the data doesn't confirm that. So advised households tend to have better financial outcomes over time than non-advised households. And a lot of it, it's not just financial strategy, it has to do with human nature. And we rationalize away issues. We get into our silos. We don't have broad enough perspectives. We make mistakes. We don't have people challenging our opinions about where we land on different topics financially. And then finally, we don't have someone holding us accountable to act in the way that we should be acting. So advisors play a really important role. And then finally, I think that plan sponsors really play an important role. And that one of the roles is education. We've been involved as a practice often getting called in to do workshops on investing and retirement income planning and helping to prep people. And a lot of employers like that because that's what we're licensed to do. We have liability coverage, we'll go in there. Plan sponsors are very reluctant to be directional to their employees, because they're concerned about the liability attached to that. So bringing in a professional to speak to those issues who's well-versed in the area can be a wonderful way of leveraging up the value that you provide for people through group benefits plans. And so that's a way that you can really play an active role where you've got this plan, you have different investment options, you've got people asking questions, you can bring in a professional to go over all the different options and help people have a bit of a guiding light, a north star about how they should be setting up how they're planning and fully taking advantage of the plan sponsors programs. And advisors often can play a really important role of helping to reinforce just how valuable those plans are to the staff and how they should be leveraging off those plans to achieve their financial goals. Can you maybe elaborate a little bit on the difference between what a plan sponsor is and an advisor, if someone's not really familiar with that? Yeah, so a plan sponsor would be, you know, I could be working for a company and let's say they hire Canada Life to manage their group benefits program. And one of the parts of the program is what's referred to as a defined contribution pension plan. So in that context, the employer's matching contributions by the employee into that plan, and then Canada Life will provide various investment options. So the employer is kind of the sponsor, they go out and they hire an insurance company or group benefits company to provide that service. And so that's great, they've taken the initiative to help their staff with that. But often you find there's very poor translation between the group plan and how it's really utilized by the employees. One of the things I find as well, and this is very much a reality, and if you're watching this video, you need to think through this. And I've experienced this many times in my career. So you have these plan sponsors, they're putting money in the pot, the employees are, you know, having a deduction off payroll, money's going into the plan. And now you've got Canada Life or Great West Life or, you know, other plan administrators who are managing the plan, providing investment options. And they're really happy about the fact that they provided a cost effective option. So the management expenses or the fees for that plan are extremely low. But what happens is very often the employees get what you pay for. So number one, they've got investment options. Number two, systematic and automatic. Number three, often the plan sponsors, in collaboration with the group benefits companies, do a poor job of translating practical, customized action plans for the employees. There's a huge disconnect there. And then the other part is that when employees want advice, it tends to be very generic and really not customized, or the individuals that are just don't have the expertise to do it properly. So what ends up happening is people are really, really not informed about their options as well as they should be. And they're not doing proper planning. So we've been hired to come in and do customized workshops. And then that gets translated into one-on-one coaching to help people leverage off their group benefits plan. And in fact, if you're an employer and you're watching this, and you're going, you know, maybe we should sponsor a virtual seminar or series of instructional videos that are interactive with our teams to go over the group benefits plan and integrate that into retirement income planning, make sure you go to the show notes of this particular podcast. You can reach out to us and say, hey, let's have a conversation. We think education is going to be pivotal to help our staff make use of these valuable programs that we have put together. We don't think that that's happening right now. So it's a really important piece. So the next question is, how does socioeconomic status affect longevity? And what are some broader implications surrounding that? Yeah, that's a complex one. And, you know, That's a pretty broad question. Yeah. But I do think that there's no doubt that there are differences in longevity. There are differences in economic opportunity. And so one of the issues that comes up is, you know, how does society structure their offerings, both from an employment standpoint and group benefits standpoint, to help people have the best chance possible to develop an income security plan. And that's a whole society kind of enterprise. It's government, it's employers, it's employees taking personal responsibility to try to move people in the direction of, you know, both financial health and physical health and educational health. That's a really, really big question. And unfortunately, it's becoming even more important. One of the big trends in our society over the last 40 years has been this movement away from defined benefit pension plans for employers to defined contribution pension plans. It's often positioned as a great benefit and lots of flexibility for employees. But the reality is, with a defined benefit pension plan, you put your years of service in, you get a defined benefit, fixed income payment for the rest of your life. You don't have to worry about managing your portfolio. You don't have to worry about making investment decisions. It's just a monthly income. And those plans are getting more and more rare. In fact, they're very rare. So what's happened is people are now having to take on the responsibility of making investment decisions. They're having to take on the responsibility of how much do I need to save for retirement. They're having to take on the responsibility of coordinating those decisions. And unfortunately, not enough people seek advice and counsel. And as a result, they're making subpar decisions around their planning. So that's an overall sort of economic decision that employees have made. I understand why. It's less costly for them. Defined benefit plans are expensive to administer. But as a consequence, a lot more is being put on people's shoulders to figure out their retirement. So we basically covered what we wanted to in this video. And so before we end it off, what I want to do is kind of summarize the different topics that we talked about. And so you've probably forgotten some of the key components of our video. So longevity risk, which is the risk that individuals will outlive their retirement savings. The three pillars that we discussed were the contribution rate, the accumulation period, and your investment choice. And then we talked about some of the socioeconomic factors that you want to keep in mind and the shift away from defined benefit to defined contribution plans and really the importance of an advisor, I would argue. And so if you're watching this, you're young, you're far away from retirement, but you don't have a lot of clarity as to how much you need to save to reach your retirement goals. And you want a plan that can really illuminate the next 30 years of your financial journey. Make sure you go to the description down below and go to our website and fill out a submission form. We'd love to have a chat and to help you with your planning. So John, if there's nothing else you want to discuss, I think we'll leave it off there. Thank you for watching and we will catch you in the next video.