Designing a Retirement Savings Plan

After talking about the ridiculous housing situation in Canada for a few weeks, one thing I've been hammering home is the dangerously low savings rates in Canada. About half of Canadians have less than $10,000 saved, only 60% of us are saving something for retirement at all, and a full one-third of us admit we have no idea how much we need to save for retirement.

To top this off, nearly 40% of savers are pillaging retirement accounts to pay for credit card bills and houses. Embarrassingly, although 60% of us save for retirement, the average saver over 55 years old has merely $125,000 in their investment accounts! Using our 20x Rule, that translates to a retirement income of just $6,250 per year... ouch!

You'll notice I have not talked about paying off a mortgage instead of real investing: the current paradigm in Canadian finances. This is because a paid off house gives you next to nothing. A house is a non-productive, no-income generating, costly to maintain arrangement of chipboard, sticks, vinyl, and asphalt. The only thing a paid-off house does is displace about $15,000 of annual expenses... maybe. At 20x, your source of shelter is worth $300,000 tops in my investment account.

Planning Ahead

If you're reading this blog, chances are you at least have some knowledge of the power of self-managing your investments with Questrade, keeping your costs low with index ETFs, and what it means to invest in a disciplined style that generates long-term success. This is important!

To figure out your retirement needs, it's important to adjust all your numbers for inflation. The average Canadian couple will spend $40,000 to $60,000 a year with a paid off house and no external debts. If you're renting add about $15,000 to that. This income level will pay for a lifestyle that includes vacations, some eating out, and fun activities—comfortable, but not lavish, spending.

The next step is to plan your desired retirement age because this helps you estimate your safe portfolio withdrawal rate. I'm going to base my numbers on the 20x Rule to allow for a standard retirement in your mid-60s.

The third—and easily most important—factor is when you start saving. Compound interest is a powerful force. In a Growth Portfolio, you can double your money approximately every 12 years with no new contributions using historical data. Saving young gives a powerful advantage that's very difficult to make up later.

The Only Equation That Matters

[(Your Estimated Spending - CPP) x Your "Rule")] = Your Required Portfolio (in today's dollars)

Once you have your required portfolio number, all it takes is a simple compound interest calculation to get your minimum regular monthly contributions.

Your Required Portfolio / [(1.005^(12 x Years of Saving) - 1) / 0.005] = Minimum Monthly Contribution (in today's dollars)

For example, let's say I'm 30 and want to retire at 65. I spend $50,000 a year with a paid-off house. I currently will have 35 years (or 420 months) to save for retirement. I'll estimate $10,000 for CPP. (CPP is funded in a defined-benefit pension format and is highly likely to provide benefits for a long time in its current form.) I don't include OAS as it's drawn from annual government revenues as a form of wealth transfer. OAS benefits could quickly be reduced if the government needs to cut their spending levels.

What's my Required Portfolio? $800,000 = [($50,000 - $10,000) x 20]

How much do I have to save per month? $562 = $800,000/[(1.005^(420)-1)/0.005]

I would say every young Canadian should be saving at least $562 a month for a decent retirement. This is in addition to paying your mortgage! $562 a month translates to about 8.5% of gross household income in Canada. More than double our current savings rates.

What you do have to keep in mind is your monthly savings must be adjusted up for inflation each year. This can be done by increasing your savings every time you get a raise. Otherwise 35 years from now I'll have my $800k, but prices will probably have more than doubled by then so it would be worth less than $400,000 in today's spending power.

What is your monthly savings number given your desired spending and number of years to retirement?

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