A new year tends to get retirement investors putting some hard thought into when, and how, they can retire.
The size of your nest egg hinges on how much you can sock away over the years, but you won’t likely get to that golden sunset unless your investments can grow and compound over time.
As the safety of defined-benefit pensions gives way to market linked defined-contribution pensions, the vast majority of Canadians need to invest to enjoy a comfortable retirement.
Most investment advisors say targeting inflation-adjusted, long-term average annual returns of four per cent to six per cent is realistic, but it depends on an individual’s retirement goals and tolerance for risk.
How to use the Rule of 72
A qualified investment advisor should have the most accurate tools to calculate the average annual rate of return needed to get a client to their retirement goals.
One simple way to get a ballpark figure of the rate of return needed for an investment portfolio to double or quadruple over a certain period of time is through the Rule of 72. It’s a complicated mathematical formula that divides 72 by the annual rate of return.
As examples, the Rule of 72 estimates that $1 invested at an annual fixed return of ten per cent would take 7.2 years (72 divided by 10 = 7.2) to grow to $2.
Put another way; to double your money in six years you would need a 12 per cent rate of return.
The Rule of 72 is most accurate for rates of return of between five per cent and 10 per cent.
Investopedia has a more comprehensive breakdown
Balancing risk and returns
A qualified advisor can help target realistic returns for individual clients by understanding their retirement goals and tolerance for risk.
As a general rule, the potential for big returns is greater when the investor takes greater risk. Investing over the long term brings an opportunity to strike a balance between risk and returns.
The goal is to manage risk without sacrificing rewards by diversifying investments across equity sectors and geographic regions, and fixed income such as bonds.
As we near retirement, risk and reward are ratcheted down to ensure we hang on to what we have.
As an example, guaranteed investment certificates (GICs) generated a risk-free yield of about five per cent in 2024. In contrast, a basic semiconductor exchange traded fund (ETF) returned 150 per cent in 2024 - but it was far from guaranteed. Returns that high are unsustainable.
Inflation can take a big bite out of returns and that’s why it’s important to select investments that can best absorb the higher cost of living.
Risk-free returns
One way to lock in solid returns and leave more of your tax dollars compounding in your portfolio is through an effective tax strategy.
A good advisor should know the basics, but do-it-yourselfers can defer paying tax on their investments through a registered retirement savings plan (RRSP). RRSPs allow contributions to grow tax-free in just about any kind of investment until the funds are withdrawn, ideally at a low marginal rate in retirement.
To avoid high taxes if your RRSP investments grow too much, contributions can be diverted to a tax-free savings account (TFSA). TFSA contributions can not be deducted from income like an RRSP, but any funds withdrawn will escape the claw of the Canada Revenue Agency.
Another risk-free way to boost returns is by keeping investment fees low. Generating consistent returns, on target, requires professional management but there is point when fees become a drain.
A money manager with a two per cent fee must generate eight per cent to return six per cent to you, as an example.
If you pay fees exceeding two per cent on your entire portfolio, it might be time to shop around.