The problem
Investment risk for retirees is without question a big deal, and rightly so. The dilemma is:
- the right investment mix to provide us with enough money for the journey in some style
- without taking risks that might put a bomb under our plans.
So we read the papers, listen to the news and watch the talking heads on TV. And you know what the problem with that is? They talk endlessly about precisely the wrong thing!
Every day it’s “The stock market was down (or up) 1.2% today” or “property prices down (or up)”, or “billions wiped off super funds”.
Maybe that sells papers and satisfies the demands of the daily news cycle, but that is the last thing you should be worried about!
Two Questions
Let’s take a step back and ask ourselves two questions:
~Novel Serialisation: Heavens Fire~
Q: What changes when we retire?
A: It’s the way the cash flows. Before you retire you’re building up your nest egg, afterwards you are drawing it down, to live on. Which doesn’t sound earth-shattering – does it really matter much?
Oh, yes! Big time. Living off your investments, rather than accumulating them, is a totally different ballgame.
Before you retire, you don’t really have to worry too much about things like risk and volatility. If things go a bit pear-shaped for a while, well, it’s no fun, but at least you have the luxury of time and a regular pay cheque to aid in the recovery. Not so after retirement. More on that in a moment.
Q : What makes up the return you get from an investment?:
A: Income. Shares pay dividends, property pays rent, bank deposits pay interest
– Capital gain (or loss). In other words, the change in the price of what you own. Day to day price can vary widely – just ask the Talking Heads. But that’s just noise. It’s what happens over the long journey of retirement that’s of more concern.
The Simple Truth
And now at the risk of stating the obvious, here is the simple truth:
- You eat income
- You don’t eat prices.
Before retirement, this distinction doesn’t matter much because your employment income pays for the food.
But after retirement you look to your investments to pay the bills.
If you are in the fortunate position whereby the income part of your return is enough to cover your costs, you’re in a happy place.
But most of us are not, and that’s quite OK.
It means though that along the way we have to systematically cash in chunks of our money. And, make no mistake. In terms of investment risk in retirement, this is where the rubber hits the road.
There are only two days when the price of your investment matters – the day you buy, and the day you sell. What happens in the middle is of no real consequence. You are at no risk from fluctuating prices if you don’t have to sell.
If you do have to sell, you want to be sure it’s at a good time (when prices are up), not a bad time. If you are forced to sell assets at the wrong time, then you crystallise a loss and make it permanent. This destroys wealth that will never be made up.
The Essence
That, right there, is the absolute essence of investment risk for retirees – The risk around the quantity and timing of the sale of assets to supplement your income.
And the way most pension funds are set up – that is, by regularly cashing in units to fund pension payments, there is no control or management of the process, it is simply random. “Here’s the fund, go take your chances”.
The moral of the story…..
- Don’t be scared off by the daily news about markets wobbling. They’ve always done that, and always will
- But to manage the short term price fluctuations and not be permanently damaged by them, you need to have things set up so that you don’t have to cash in assets at the wrong time.
How do you do that?
- First and foremost, know and understand your cash flow position. Not just for the coming week, but how you are positioned for the future. Retirement is all about cash flow – you really need to get a good handle on it.
- Importantly, understand how much of your spending requirements will be met by the income part of the return, and how much will require actually selling stuff.
- Set up your portfolio so that your immediate and near term cash needs are covered by your income plus an appropriate level of cash and very stable reserves. This will help you ride through those awkward times when prices are unfavourable.
- Look to invest for lower volatility. The set-and-forget passive approach may leave you vulnerable to the whims of the markets. There are strategies out there that capture much of the market upside, but also offer some protection against the downside.
Doing this could be the ticket to the best of both worlds. A decent return, and a good night’s sleep!
By Alan Rimmer
About the author
Alan Rimmer is the founder and principal of ARA Consultants Ltd. For more than 20 years ARA has specialized in retirement planning and currently assists some 700 families with their financial affairs.
Visit www.araconsultants.com.au if you would like to know more.
A great article…thanks for sending it