Finding the right retirement planning matrix (Pt 1)

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    People are living longer but not necessarily healthier. They should be prudent with their finances and make sure they don’t outlive their assets. But they shouldn’t do it to the point where they no longer enjoy life just to save for the later years. > Vettese
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This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on July 11 - 17, 2016.


Retirement planning strategies that worked well in the past are no longer effective today with the changing global environment. It is time to discard outdated investing principles and adopt a more flexible approach to designing one’s retirement strategy.


Retirement planning is tough. And most of the time, it is made tougher by the voluminous literature on the subject as well as advice from financial planners and retirement planning experts.

In a changing global environment and with the demographic shifts over time, strategies that worked well in the past may not be as effective today. There is certainly no one-size-fits-all model when it comes to retirement planning. 

This is where author and actuarist Frederick Vettese comes in. He is in the camp of advisers who believe some of the retirement planning principles adhered to by many people are no longer applicable today.

“Some of these are myths and do not make sense, but many people don’t seem to understand that. Some banks and companies even try to push these myths one step further by suggesting that the retirement income target, for example, should be higher at 75% or 80%. I think we should dispel some of these myths,” he tells Personal Wealth. 

Vettese’s views are refreshing. He even suggests that there could be “overproviding for retirement”, based on some of the retirement planning guidelines out there. 

His underlying argument is this: Saving for retirement is a two-dimensional problem — the more you save in pre-retirement years, the less you have left to spend when you are still active in the workforce. This is not an ideal situation. The solution, he says, is moderation — saving and spending moderately pre and post-retirement. This is what people should seek to achieve. 

Vettese has 40 years of experience in the area of retirement planning. He is the author of The Essential Retirement Guide: A Contrarian’s Perspective and in 2012, he co-authored The Real Retirement: Why You Could Be Better Off Than You Think, and How to Make That Happen with Bill Morneau, Canada’s current finance minister. He is also chief actuary at Morneau Shepell, a leading human resources consulting and technology company and one of the top five defined benefit pension plan providers in North America.  


Debunking some common retirement myths

The key takeaway from Vettese’s new book is that people should do what they want while they still have the ability to do it right after retirement as that time will be shorter than they think. 

“People are living longer but not necessarily healthier. They should be prudent with their finances and make sure they don’t outlive their assets. But they shouldn’t do it to the point where they no longer enjoy life just to save for the later years,” he says. 

Instead, one should find that right balance between saving and spending to avoid getting into a situation of financial deprivation, whether it is before or after retirement. In this regard, Vettese does not agree with the commonly espoused 70% retirement income target. “Does the middle and upper-income group need this much to enjoy a comfortable retirement?” he asks.

“We need to save as much as 20% during our employment years to get to a retirement income target of 70%. If you put away 20% of your income for retirement savings, 20% for child raising and 25% for mortgage payment, you will only be left with 35% for personal consumption,” he points out.

“The question is, if we can get away with 35% for personal consumption when we are still very active, why would we need 70% in our retirement years, when our spending eventually decreases as we age? The math simply doesn’t add up.” 

The retirement income target for the upper and middle-income group can be as low as 35% to above 50%, says Vettese. This depends on a person’s income and marital and house ownership status, not forgetting his current commitments, savings and investments, as well as the desired retirement age and any inheritance. 

He does not agree with the 4% retirement spending cap, which is an assumption that if one withdraws that amount from their nest egg in the first year of retirement, the remainder would earn sufficient income from returns on investments to recover what had been withdrawn earlier. The 4% cap was recommended in a 1994 study by American financial planner William Bengan, where upon analysing historical rates of return over three decades, he concluded that 4% was the best withdrawal rate for retirees.

Vettese says the problem with the 4% rule is that it has many flaws, including unrealistic returns that underestimate the real returns on investment, leaving too much on the table which may prevent the retiree from enjoying his retirement years, and withdrawals that do not match spending patterns as people tend to spend more in the early years of retirement. 

“Upon retirement, retirees should be able to comfortably withdraw much more income to enjoy their life. Several researchers in Germany, the US and the UK have proven that spending decreases with age,” he says. 

“People would be better off spending more in the early stage of retirement and spending less later on when factors such as illnesses and physical inabilities affect their spending pattern. This is exactly the opposite of what the 4% rule suggests, and why I think people can withdraw more than 4%.”

Taking into account the fact that spending decreases with age, Vettese says retirement income from retirement savings does not have to be indexed to inflation when determining the wealth target. “By not indexing to inflation, it means that retirement income can be a level amount, instead of an amount that increases each year in line with inflation. I am assuming that inflation will stay at a low level — about 2% a year — and that any government pension is fully inflation protected.

“Retirement income will still rise a little every year but will not be enough to keep up with inflation. This is acceptable as the findings in my book show that spending does not keep up with inflation, especially after the age of 70.”

Vettese concedes that when people spend more than what they get from the returns on investment on the remaining amount in their nest egg, they are slowly eating into their principal savings. However, this is not a problem if they take measures to prevent that from happening, especially in an environment of low or even negative interest rates.

This means, among other things, reviewing their investment portfolio to keep abreast of developments in the investing environment. Currently, a factor to consider is the low to negative interest rates when weighing the return on investment post-retirement.

“Interest rates will stay very low over the next 20 years, that is, if negative interest rates do not become the new normal. This will result in lower bond yields and investment returns,” says Vettese. 

Another implication of low interest rates is that if real returns are around 3% or 4% a year, it means certain things have to change. For example, asset classes such as unit trust funds would have to lower their upfront charges or risk becoming unattractive in investors’ eyes. 

“These days, I am assuming a 5% to 5.5% return on investment. But this is because I overweight equities. For investors who are more conservative, their returns will be even lower against today’s backdrop,” he says.

Vettese’s own portfolio currently holds about 75% in equities, which are widely spread among emerging markets, the US and Canada; 10% in fixed income; and the rest in absolute return funds and cash. His advice to investors is to stay fully invested within his recommended allocation. “In the longer term, such as five years, equities will almost always yield better than bonds,” he says. 

He does not advocate timing the stock market as no one ever get that right consistently. “I am not an investment expert. All I can say from observing the forecasts of self-styled experts over the past 40 years is that the future is essentially unknowable. Keep this in mind as this may help guide your actions. That is why I am considering buying an annuity using half of my assets and keeping the other half in equity funds when I am 70.”


Finding the right retirement planning matrix (Pt 2)