Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 284

7 retirement challenges need a different focus

In the past, most Australians have been in accumulation phase of superannuation, with the primary objective of building wealth. But that started to change in 2011 when the first of 5 million Australian baby boomers hit retirement age. Every day another 800 baby boomers retire, and the result is that a large proportion of the population now has significantly different investment needs than in the past.

Unfortunately, most funds are not sensitive to the unique needs and challenges of post-retirement. Super funds are offered indiscriminately to all investors, both accumulators and retirees, and simply focus on a total return outcome and attempting to beat their respective benchmarks.

Amid a suite of investment strategies and tactics, we believe there are seven key factors that are vital to shifting an investment approach’s focus from accumulation to one more suitable for retirees.

1. Limiting large losses

While younger people can weather steep falls in markets and can even take advantage of them by buying low, retirees – with no future contributions to make and without the luxury of time to wait for markets to recover – could be forced to sell assets at low prices to fund their retirement.

Therefore, retirees (or their fund managers), need to be aware of how large negative returns could become in any single stress event and they need to be actively managing that downside risk, particularly at the start of retirement.

One way to do this is to invest in portfolio protection, typically in the form of equity options, which can help to mitigate the risk of a large loss by smoothing returns.

2. Managing behavioural risk

Human instincts can be our own worst enemy and the natural response of a ‘flight to safety’ can destroy significant wealth if applied to financial markets. To exacerbate the issue, non-advised investors can easily access and change their investment mix via super fund online portals or directly via SMSF structures, which means that investors managing their own investment strategy can more easily fall victim to their behavioural instincts.

In our experience, investors are much less likely to be reactionary if they have clear goals set for retirement, are aware of the types of losses they could incur in a single market event, have portfolio protection (as discussed above) in place, and are aware of other actions they can take to combat poor performance such as adjusting their lifestyle or potentially increasing their risk exposure.

3. Focussing on income over growth

An investment strategy that prioritises income over growth offers significant benefits to retirees.

The primary benefit is matching their cash flow needs with assets that continually produce cash flow via dividends, coupon payments or rent. Additionally, when income in equals expenditure out, investors have less need to sell underlying investments to fund their lifestyle, allowing them to ride out market volatility and reduce transaction costs.

However, investing for income can be overdone; what is needed is a balanced approach that invests in quality assets with resilient income streams and stable capital values.

4. Managing duration

Duration is an approximate measure of a bond's price sensitivity to changes in interest rates, expressed as a number of years. For example, if a bond has a duration of five years its price will rise about 5% if its yield drops by 1%, and its price will fall by about 5% if its yield rises by 1%.

As the objective of retirement savings is to fund the retirees’ future outflows, it is essential to understand how both the value of those outflows and of the retirees’ current assets would be affected by changes in interest rates.

To remove uncertainty around interest rates, the duration sensitivity of the assets can be matched with that of future consumption; this is referred as asset-liability matching. Or if there is an expectation that interest rates will rise in the future the portfolio can be actively tilted towards shorter-duration bonds, which have less interest-rate risk.

5. Inflation awareness

When in accumulation phase, inflation is not such a big threat because as the cost of living rises, so do earnings. But it’s a different story for retirees as an inflation spike means they pay more for their basic living expenses, such as groceries and utilities, without a rise in income to help meet those additional costs.

Yet many retirees are invested in conservative and moderately conservative index funds which have a large exposure to government bonds and duration, which underperform when inflation spikes.

Instead, retirees should hold assets that work to combat inflation risk such as inflation-linked bonds (rather than nominal bonds) and tilt toward sectors that have revenues linked to inflation such as infrastructure, property, energy and agriculture.

6. Managing liquidity

For investors, liquidity is the ease with which they can exit an investment at a favourable price, with reasonable fees and in a timely manner, should they need their funds immediately. As unexpected costs do arise in retirement (often in relation to health) having a strategy to manage liquidity in retirement is important.

Given the illiquid nature of property and some annuities, the retiree’s account-based pension is typically the first point of call for emergency funding. If invested in a managed fund, the retiree should check that it offers daily liquidity, can be sold at a reasonable ‘sell spread’ and 90% or more of its holdings are in liquid assets.

If, in addition, retirees hold direct investments, they should also be aware of their portfolio’s combined liquidity profile.

7. Tax awareness

Some retirees might think that they don’t have to worry about tax given they are no longer working, but by investing retirement savings in a tax-aware manner, the result can be a boost in income. To that end, there is a growing awareness of the role that franked equity dividends can play in a retirement strategy.

Franking credits – the tax credit investors can claim for tax already paid on a company’s corporate earnings – became refundable in the early 2000s.

Investors who pay lower tax (including retirees) receive a cash payment for the difference between any franked rate of dividend income and their individual tax rate. For retirees on a 0% tax rate, they receive an uplift of up to 43 cents on each dollar of fully franked dividend. For every 70 cents of dividends, investors can receive a tax credit of up to 30 cents, which equates to 43 cents per dollar of dividends.

Final thoughts

During the dark days of the global financial crisis many retirees panicked and sold out of investments at the worst possible time. But even more concerning were the stories of retirees scrimping and living below the poverty line, worried about their future.

Our investment approach for retirement has for too long been modelled off the approach developed for younger accumulators, yet the risks that need to be managed are vastly different.

By considering these seven factors we will be more likely to have a generation of retirees who are confident in their investments, more likely to stay the course and able to enjoy the best retirement they can afford.

 

Darren Beesley is a Senior Portfolio Manager at AMP Capital, a sponsor of Cuffelinks. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs.

For more articles and papers from AMP Capital, please click here. To view AMP Capital's new video on ESG investing, click here.

banner

Most viewed in recent weeks

Unexpected results in our retirement income survey

Who knew? With some surprise results, the Government is on unexpected firm ground in asking people to draw on all their assets in retirement, although the comments show what feisty and informed readers we have.

Three all-time best tables for every adviser and investor

It's a remarkable statistic. In any year since 1875, if you had invested in the Australian stock index, turned away and come back eight years later, your average return would be 120% with no negative periods.

The looming excess of housing and why prices will fall

Never stand between Australian households and an uncapped government programme with $3 billion in ‘free money’ to build or renovate their homes. But excess supply is coming with an absence of net migration.

Five stocks that have worked well in our portfolios

Picking macro trends is difficult. What may seem logical and compelling one minute may completely change a few months later. There are better rewards from focussing on identifying the best companies at good prices.

Six COVID opportunist stocks prospering in adversity

Some high-quality companies have emerged even stronger since the onset of COVID and are well placed for outperformance. We call these the ‘COVID Opportunists’ as they are now dominating their specific sectors.

Let's make this clear again ... franking credits are fair

Critics of franking credits are missing the main point. The taxable income of shareholders/taxpayers must also include the company tax previously paid to the ATO before the dividend was distributed. It is fair.

Latest Updates

Retirement

10 reasons wealthy homeowners shouldn't receive welfare

The RBA Governor says rising house prices are due to "the design of our taxation and social security systems". The OECD says "the prolonged boom in house prices has inflated the wealth of many pensioners without impacting their pension eligibility." What's your view?

Interviews

Sean Fenton on marching to your own investment tune

Is it more difficult to find stocks to short in a rising market? What impact has central bank dominance had over stock selection? How do you combine income and growth in a portfolio? Where are the opportunities?

Compliance

D’oh! DDO rules turn some funds into a punching bag

The Design and Distribution Obligations (DDO) come into effect in two weeks. They will change the way banks promote products, force some small funds to close to new members and push issues into the listed space.

Shares

Dividends, disruption and star performers in FY21 wrap

Company results in FY21 were generally good with some standout results from those thriving in tough conditions. We highlight the companies that delivered some of the best results and our future  expectations.

Fixed interest

Coles no longer happy with the status quo

It used to be Down, Down for prices but the new status quo is Down Down for emissions. Until now, the realm of ESG has been mainly fund managers as 'responsible investors', but companies are now pushing credentials.

Investment strategies

Seven factors driving growth in Managed Accounts

As Managed Accounts surge through $100 billion for the first time, the line between retail, wholesale and institutional capabilities and portfolios continues to blur. Lower costs help with best interest duties.

Retirement

Reader Survey: home values in age pension asset test

Read our article on the family home in the age pension test, with the RBA Governor putting the onus on social security to address house prices and the OECD calling out wealthy pensioners. What is your view?

Sponsors

Alliances

© 2021 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.