A change of focus required for retirement

Posted on 17 January 2019

Over the past few years we have seen many changes with regards to both the general economy and the growing number of retirees relying on deriving their retirement incomes from their superannuation investments.

Unfortunately, most super funds are not sensitive to the unique needs and challenges of post-retirees. The funds are offered indiscriminately to all investors (both accumulators and retirees) and the focus is on total return outcome and attempting to beat their respective benchmarks.

They are 7 key factors to consider in shifting the investment focus from accumulation to retirement.

1. Limiting large losses

While you are young you are able to weather steep falls in markets and can even take advantage by buying low. However, as a retiree with no further contributions to make and without the luxury of time to wait for markets to recover, you may find yourself forced to sell assets at low prices to fund your retirement.

Therefore, as a retiree it is important to be aware of how large negative returns will impact your retirement and where possible you need to try and manage the downside risk.

We recommend the most straightforward to do this is to reconsider your exposure to growth assets, perhaps it may be in your best interests to reduce your exposure to those assets that are more susceptible to the highs and lows of market volatility.

2. Managing behavioural risk

Our instincts can be our own worst enemy and the natural response of a “flight to safety” can destroy significant wealth if not properly considered before acting.

This is where having a financial adviser can really provide maximum benefit. It is their role to help you navigate through these times. These days it is very easy for investors to change their investments online on a whim.  A non-advised client runs the risk of being driven by their “instincts” and not thinking through the ramifications of their actions.

Our experience indicates that investors are much less likely to be reactionary if they have clear set goals. It is important to be aware there are other alternatives to selling down. These include adjusting your lifestyle or potentially decreasing your risk exposure.

3. Focusing on income over growth

The main benefit of prioritising income over growth for retirees is it allows you to match your cash flow needs with assets that provide an ongoing cash flow via dividends, distributions or rent. When income equals expenditure, investors have less need to sell underlying investments to fund their lifestyle, allowing them to ride out market volatility and reduce transaction costs.

It is important though to use a balanced approach and not solely focus on income. You should be looking at investing in quality assets with resilient income streams and stable capital values.

4. Managing duration

Duration is the measure of a bond’s price sensitivity to interest rate changes expressed as a number of years. I.e. a 5-year bond’s price will likely rise 5% if its yield drops by 1% and its price will fall by about 5% if its yield rises by 1%.

As a retiree you need to understand how both the value of outflows and your assets would be affected by changes in interest rates.

One way to reduce some of the uncertainty around interest rates is to try and match the duration sensitivity of the assets with expected future consumption (known as asset-liability matching). If interest rates are expected to increase in the future, then the portfolio can be actively tilted towards shorter duration bonds which have less interest rate risk.

5. Inflation awareness

Prior to retirement, increased inflation is not a major problem. This is because as the cost of living increases so should a person’s income. However, for retirees there is no increase in income and therefore increased inflation means an increase in the cost of living that needs to be funded.

This can be acerbated as many retirees are invested rather conservatively. They are likely to have a higher exposure to fixed income securities (government bonds) of a longer duration which underperform when inflation spikes.

Therefore, it is important that as a retiree you look at holding assets that work to combat inflation risk such as inflation-linked bonds and tilt towards sectors that have revenues linked to inflation such as infrastructure, property, energy and agriculture.

6. Managing liquidity

Liquidity refers to the ease with which an investment can be exited at a favourable price with reasonable fees and in a timely manner.

Unexpected costs can easily arise in retirement and therefore it is important that retirees hold some investments that are reasonably liquid.

Given the illiquid nature of property and some annuities, it is often a retiree’s account-based pension that is the first point of call in order to meet these costs, therefore it is important that the at least some of the investments chosen within the account-based pension are reasonably liquid.

7. Tax awareness

As a retiree you still need to consider the tax effectiveness of your investment options. Investing in good quality stocks that provide franked equity dividends is an example of a tax effective investment that can actually boost the income you receive.

Investors who hold stocks paying franked dividends and who fall into a lower tax bracket may receive a tax refund for the difference between any franked rate of dividend income and their individual tax rate. For retirees on a 0% tax rate you should receive an uplift of 43c on each dollar of fully franked dividend. For every 70 cents of dividends, investors can receive a tax credit of 30 cents which equates to 43 cents per dollar of dividends.

Summary:

During the global financial crisis many retirees panicked and sold out of the investments at the worst possible time.

By considering the 7 factors above, retirees can be more confident in their investments and therefore are more likely to stay the course and be in a position to enjoy the best retirement they can afford.