Every transition in life is challenging. As creatures of habit, we often find change difficult. Transitioning from a regular pay check to funding life from a portfolio is a significant shift for many investors. It also necessitates a change in strategy and approach.

To ensure you are prepared for this transition as an investor, consider undertaking the following three steps:

• Create a budget
• Review and refine your investment strategy
• Plan for contingencies

Creating a Budget: Retirement might be the time to overcome any aversion to budgeting. There are two approaches to setting a retirement budget. The first is the proactive approach, which involves determining the amount of money needed to support a desired retirement outcome and creating a plan to achieve that outcome. This approach assumes that an investor has enough time to course-correct and achieve the desired outcome. However, many people do not have this luxury, as it requires significant lead time, sacrifice, and planning—things that many people are reluctant to do. For investors approaching retirement, there may not be enough time to work towards the desired outcome. Instead, the focus should be on the amount a portfolio can support annually.

There are two ways an investor can approach this:

1. Safe Withdrawal Rate: The amount that can be withdrawn from a portfolio annually until death without running out of money depends on several factors:

• The future returns of the portfolio
• The sequence of those returns
• The level of future inflation
• The time until death

All these factors are based on an unknowable future. We can make educated guesses for future scenarios based on history and current market conditions. However, an educated guess is still a form of speculation. For many retirees, it pays to be conservative, as there is asymmetry in this speculation. Having some money left over at death is far preferable to running out of money before death. Personal factors should also be considered. Are there children or an aged pension that can be relied on if markets do not cooperate? Is leaving an estate to relatives or a charity important? Each retiree will have to make their own determination.

2. Living Off Income: Another approach is living off the income generated from a portfolio. Setting a budget using income requires looking at the current yield of the portfolio and accounting for the natural variability of income as dividends and interest rates fluctuate. Any budget should incorporate the natural shift in spending that occurs during retirement. Many retirees tend to spend more money at the beginning of retirement when health allows for more costly activities like travel. This spending tends to decrease as people age and can spike towards the end as health issues mount. One important consideration is that mandatory super drawdowns are not designed with a retiree’s best financial interests in mind. Taking money out of super does not mean it needs to be spent. Money taken out of super can be invested or held in cash outside of super.

1. Review and Refine Your Investment Strategy: Every investor needs a plan. A plan connects goals with the investing strategy that will be used to achieve those goals. It includes criteria for evaluating investment opportunities and assessing portfolio performance. An investor approaching retirement should review their strategy to determine if any changes should be made to goals, asset allocation, and security selection criteria. Asset allocation and security selection are two areas that may need refinement. Asset allocation is likely the biggest driver of long-term returns. Traditionally, retirees have allocated a larger percentage of their portfolio to defensive assets to lower volatility. This makes sense to a point. Getting too conservative can reduce the longevity of a portfolio that supports regular withdrawals. There is no right answer here. Personal circumstances will play a significant role in the decision-making process.

If there are other sources of assets and income, such as an aged pension, an annuity, or an investment property, a retiree may choose to retain a larger allocation to growth assets. The proportion of wants versus needs in a budget may also play a role, with a lower percentage of needs allowing for a larger allocation to growth assets. Owning a house outright is an example of one of the primary and most expensive human needs being removed from a day-to-day budget. Some retirees may not need to change their asset allocation at all. Many retirees are choosing to continue holding a high allocation to growth assets. However, a review of asset allocation should focus on the impact of volatility and other factors on the ability to meet a retiree’s spending needs and the longevity of the portfolio.

The biggest risk most investors face is not achieving their goals. An investment plan and strategy should shift focus to account for the unique risks that pre-retirees and retirees face.

For investors approaching retirement, two common risks are not meeting the milestone of retirement and running out of money before death. As retirement becomes imminent, the biggest risk is being forced to start selling in a down market. Ideally, everyone would retire when markets are rising. However, in reality, many people have little choice regarding the timing of retirement and no control over market conditions when they retire. Retiring in a down market means that investors need to sell assets when they have fallen in value. When markets recover, there is a smaller portfolio to take advantage of the rising prices. This is a significant problem because the length of time a portfolio will last under any withdrawal scenario will be lower. In some cases, it could be significantly lower.

A plan should address this scenario and outline the approach an investor will take if markets start to meaningfully fall as retirement approaches. One way to address this risk is to delay retirement. That may not be an option for some investors, and it may be an unpalatable choice for others. Determine if delaying retirement is an option. Another way to address this scenario is to build up cash. A cash cushion can be used to fund living expenses while waiting for the market recovery to occur. Remember that markets will inevitably have poor years. The issue is not the market going down; that is life. It is being forced to sell during those down periods. While many non-retirees make the poor choice of panic selling in down markets, a retiree must sell during those periods because they need money to pay for life.

The amount of cash held is up to the retiree. The more time the cash can cover living expenses, the longer the investor can wait for the market to recover. Holding cash has a cost because long-term returns are lower than other investments. Each prospective retiree should determine what opportunity cost is acceptable given the level of comfort cash can provide. Put that number in a plan and work towards building up cash before retirement. This cash should be considered separate from an emergency fund. Even retirees face unexpected expenses, and an emergency fund should be maintained to deal with those scenarios.