Many people are familiar with investing for retirement — accumulating assets for future use — but investing in retirement tends to receive less attention. Indeed, there is a lack of familiarity with the issues that need to be considered in the de-accumulation phase of retirement. These include longer lifespans, determining a sustainable income level, preparing for unexpected life events and planning legacy assets. All of these need to be considered in the context of a post-retirement investment strategy, which is subject to financial market volatility and the effects of inflation. The bottom line is that every individual’s retirement assets will be expected to work harder for longer. Here are some practical suggestions for investors to keep in mind when discussing their retirement goals with their financial advisers.
How should retirees view their post-retirement investments?
Firstly, we shouldn’t consider retirement savings in isolation. Often people will have a range of assets they intend to draw on in retirement. For example, a retiree might have a state pension, an occupational retirement income, mutual funds, real estate assets as well as personal savings.
Given the potential range of investments in a retiree’s post-retirement arsenal – and the range of needs and wants to meet in their new stage of life – it can be helpful to identify and categorise the inputs and outputs, which are the types of expenses likely to be incurred and how they will be funded. This exercise can help facilitate investors’ conversations with advisers to assess how their retirement needs can be satisfied with the resources they have.
To pull the pieces of this puzzle together, we can divide post-retirement needs into four key categories.
The next step is for advisers to help retirees structure a post-retirement plan so that each category is matched by the most appropriate and effective investment mix.
The table shows the characteristics of each category, and importantly links each one to investor goals and objectives.
When determining which assets or investments are most suitable for each building block, it’s worth highlighting some key investment issues associated with the post-retirement phase.
1. Growth is needed to reduce the likelihood of outliving a retiree’s assets.
Investment implication: Meaningful equity exposure is needed for asset growth.
2. Preservation of wealth is more important in retirement.
Investment implication: Minimise the potential impact of market downturns.
3. The preservation of capital and the security of future income over a longer timeframe are critical.
Investment implication: Small shifts in a retiree’s income strategy, such as reducing the withdrawal rate by even just 1%, can have a dramatic positive effect on the sustainability of future income.
Cash is not always king
Perhaps a significant factor that has implications across all three principles is the over-dominance of cash in retirement assets. This is the result of a lack of financial education and awareness, where the perception is that cash is a ‘safe’ asset to hold. However, in terms of addressing these key principles over a 25-year post-retirement time horizon, cash is actually a very risky asset because it doesn’t have the same potential to provide growth or income in the same way equities and bonds do. As a result, an over-allocation to cash can undermine successful outcomes in the retirement phase. Shifting retirement funds away from cash into assets with higher return characteristics can potentially have material benefits over the longer term. For example, the UK Financial Conduct Authority has estimated that retirees wanting to drawdown their retirement assets over a 20-year period could increase their expected annual income by 37% by investing in mix of assets rather than just cash.
Connecting a retiree’s expense categories with investment types
Matching investment approaches to the appropriate expense category can help retirees plan and invest more effectively.
When discussing retirement options with a financial adviser, viewing investment options in the context of a client’s entire retirement portfolio can shine a light on areas where they might feel more comfortable in taking on greater risk to achieve some growth – because the areas that require more conservative risk levels are clearly identified and matched to appropriate lower-risk investments.
For example, the ‘Living’ category could have a higher proportion of bonds to generate income and protect on the downside. The ‘Lifestyle’ solution could have a more significant allocation to equities for greater growth potential, as well as income from dividends; while contingency assets could be invested in a strategy aimed at preservation.
One final point is that not every category necessarily warrants an equities or bonds-based solution. This is because we don’t see the benefit in forcing a rigid solution in situations where it is not warranted. For example, the family home could be a legacy investment. Investors and advisers alike need to be aware that an investment framework should allow for flexibility to apply the most appropriate overall solution.
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My cash hasn't fallen like My shares have.
@ Michael Logan Good point.