It seems inevitable that the generation that goes online to diagnose health issues will also want to manage its own retirement affairs, but with so many future unknowns – life span, spending needs, inflation and investment returns – there are not always easy, perfect solutions online.
Instead, these people will have to apply principles and best practice to safely navigate their personal situation and the market conditions that lie ahead.
The accumulation phase is simple by comparison: save 15% of your income, invest in a diversified low-cost high-equity fund and, voilà, 40 years later you should have enough for a comfortable retirement. Alternative strategies, such as stashing dollars under a mattress, or making friends in high places, may appear more lucrative but don’t have proven outcomes.
But, irrespective of how we fund our retirement, we all face the same challenge eventually: turning those savings into a steady pension that holds its value.
The safest option is an inflation-linked life annuity. This insures you against running out of money should you live to 100 or more, poor investment returns and runaway inflation. But, while you are guaranteed an income for life, you are also locked in for life to a certain income, and your capital is gone. The pay-outs end when your life does (unless you include a spousal benefit).
That turns off a lot of people. Although current annuity prices are lower than they have been for some years, and most retirees rate a secure income as their top priority, the majority don’t choose this option. They would rather keep control over their savings, usually within a living annuity. This lets them decide how to invest their money, and how much to draw every year. Plus, any residual capital goes to their nominated beneficiaries.
But this freedom comes at a price: the risk (and fear) of outliving your savings. The challenge is to draw a sustainable income without being so frugal that you can’t enjoy your remaining years.
Finding the right balance would be easy if it weren’t for the big unknown: how long does the money have to last? A life expectancy table works on averages, and will take you only so far. Your own health and lifestyle, and the longevity of your parents may be a better guide.
The pension you can safely draw will then depend on how you invest your savings. Those seeking a well-diversified portfolio effectively have a choice between a high, a medium and a low-equity portfolio. As a prospective retiree, you should invest with the optimal long-term outcome in mind.
A well-diversified high-equity portfolio has historically delivered the best returns over periods of five years and more, relative to a medium and low equity portfolio, which means your savings should last longer or afford a higher income than if you held mainly bonds and cash. But this, too, imposes an emotional cost, having to endure market volatility. And sometimes a permanent financial cost, if you run into a bear market early on, when your savings are at their peak. I
n making your decision, don’t ignore your personal risk tolerance. There is no point investing aggressively if the stress of it will make you sick. You should also consider your overall financial position.
If you have other savings, or sources of income, or are flexible in your spending, you can minimise the losses you lock in after a market crash by reducing your draw-down. This allows you to take on more volatility risk. Your asset mix is one determinant of the lifestyle your savings will sustain.
The other is fund costs. Few investors appreciate that their wealth is consumed not just by withdrawals but also by investment fees. You may be drawing down at a prudent rate, say 4% of capital, but if you incur 2% in annual fees, you are effectively spending 6% each year. Your savings won’t last nearly as long as you expect.
Index funds can be used to keep your fees below 1% pa. Moving your living annuity to a low-cost provider is another way to save money and support a higher withdrawal rate.
Designing your own portfolio is one thing, looking after it another. You can combine different unit trusts or invest in one strategic multi-asset fund. The latter is simpler and more prudent.
Emotions are your biggest enemy. A higher allocation to the share market should boost your sustainable income, but only if you don’t react to its gyrations. Those who panic and switch to a guaranteed annuity, or a more defensive portfolio, after a market crash will lock in their losses and a lower income for life. But you do have to respond to market moves.
As your own portfolio manager, you will need to re-balance occasionally to stay aligned with your plan. That may require you to invest more in equities after a market correction, the opposite of what you will want to do. Your multi-asset fund does it automatically, improving your long-term return.
In summary, your time horizon and asset mix predicate your initial draw-down rate, growing with inflation thereafter. A retirement income calculator can assist you with that. Your fees dictate how much of that you get to spend. Automated rebalancing optimises the outcome. But ultimately, it’s your behaviour that will make or break your retirement.
Moving into the dissaving phase of life is daunting, even for those who appear well-funded. We have an instinctive fear of seeing our savings shrink, and a diminishing lifestyle. That never goes away. You may despair after a market crash, or lose faith that historical return trends will persist. There is always the spectre of large, unforeseen expenses. And, of course, the risk of an inflation spike that increases your expenses, devalues your assets and makes you feel poorer.
All that is on the cards. So, while the calculator may suggest that you can safely draw down at 5%, in the real world you will have to monitor the situation, respond to developments, and cut back when necessary. Above all, though, you will need to keep your nerve and learn to live with your anxiety.
The content herein is provided as general information. It is not intended as nor does it constitute financial, tax, legal, investment, or other advice. 10X Investments is an authorised FSP (number 28250).
