You may be retired, but it’s best not to view yourself as a short-term investor. Even at the age of 80, with current longevity trends we are planning for more than 10 years and need to at least keep up with inflation into the future.
Should a retiree ever expose their investments to volatility?
Cash, while a stable investment, tends to lose value against inflation over the long term, particularly after tax. This means that we do need to include other ‘riskier’ asset classes such as shares, property and bonds to enhance the returns on a retiree’s investment portfolio.
A healthy offshore exposure is also sensible to protect yourself against imported inflation (i.e., price increases due to an increase in cost of imported products). Offshore investments also increase diversification of one’s investment portfolio, which can reduce risk. In addition to the benefit of diversification, there are many sectors / industries that we can invest in overseas that we simply cannot access in South Africa.
So, adding these asset classes to a portfolio can bring extra returns and diversification benefits, but along with extra returns they also bring some risk which increases the volatility you experience as an investor.
So, if we must take on some volatility how can we do so sensibly?
Firstly, understand your investment strategy. Know what the implications are in terms of the expected range of returns over various time periods (think in windows of 2, 5 and 10 years). Keep in mind the need to maintain a long-term view when looking at your investment returns. You cannot judge the performance of a long-term portfolio based on short-term performance.
Your portfolio should always have a reasonable balance of asset classes, depending on the return that you need to achieve based on your overall financial plan as well as the expected cash flows from the portfolio.
By holding various asset classes, you will be able to buy into markets when they offer value or take profits when markets have run. Balanced portfolios tend to offer protection by reducing the volatility of the portfolio overall.
It is important to decide on a strategy and stick to it. Don’t make changes when markets get wobbly.
How can you maximise the probability of your income lasting out your lifetime?
When implementing and managing a retirement income strategy, consider the following:
Be realistic
From the outset, be conservative when deciding how much income to draw from your portfolio.
We strongly recommend spending time with your financial planner who will help you, using cash flow projection tools, to understand what is realistic based on your investment portfolio and personal circumstances.
It’s critical as a retiree to understand your budget and live within your means, as drawing too much from a portfolio too early on can damage the capital value to such a degree that it will be difficult to reverse. Humanly, we all quickly adjust to the amount of income available each month, and psychologically, once you have become accustomed to a certain level of comfort, it may be hard to tighten the lifestyle purse strings down the line.
Also, when the markets go through a dip, the impact of any overspending is amplified, as you need to liquidate more units of your investment to achieve the same rand amount of income each month… but once liquidated and spent, that investment no longer exists to recover and produce returns when the market turns positive again.
Be balanced
Implement a drawings strategy with enough in cash and low-risk investments to cover your short-term needs. Such a strategy minimises the impact of selling investments out of your portfolio at a time when their market value is low.
It’s also a good idea to have an emergency fund so that in the event of an unexpected cashflow requirement, you don’t need to cash in investments when they are down. Practically, it also makes sense to have easy access to funds so you don’t need to make investment withdrawals each time you need to pay for things like home repairs or appliance replacements.
Some people like to make use of a “bucket” methodology, where you maintain different underlying investments allocated to varying time frames. Typically, the more conservative portion is expected to be spent first, and the more aggressive portion is allocated to long-term expected spending. While this can help manage “sequence of returns” risk, the implementation of such a strategy brings challenges, particularly in the re-balancing of the buckets. It does, however, result in a level of comfort when reviewing one’s portfolio returns.
Give yourself options of where to draw from
Besides diversification and the need to cover the risk of imported inflation, additional offshore investments should be part of your portfolio to protect your ability to enjoy the odd overseas holiday, if that is included in your retirement planning.
Just as using a cash reserve can help us avoid cashing in investments at an inopportune time, an offshore investment can help us to enjoy an overseas trip without having to lock in any exchange rate losses in the event that the rand is overly weak at the time that you need to travel.
For example, if you want to go overseas and your trip coincides with a significant drop in the exchange rate, you may wish to use your overseas investments to fund the trip so that you don’t lock in exchange rate losses.
Having a part of your portfolio allocated to such an offshore strategy gives you options of where to draw from depending on market conditions.
This concept is called “asset-liability matching” i.e., investing in a way that matches your future expenses (such as foreign exchange spending) to your assets (in this case, foreign invested assets).
Depending on your scenario, be prepared to be flexible
When you set up your retirement plan, it’s important to consider inflation when deciding on your reasonable income needs (matched to your budget). With this in mind, we would expect that you would need to increase your income by inflation each year. However, in years when markets have lost value, a highly effective way to extend the longevity of your capital is to take a below-inflation increase, or to take no inflationary increase at all.
Knowing your budget and being realistic about your needs will help you understand what expenses you can cut if necessary. Downsizing your budget (or even taking a below-inflationary increase) is never easy, but in some cases it may be necessary. And the earlier that this happens the better. Keep in mind that when markets return to the good years, it could be possible to recoup the shortfall.
Summing it all up
Once a market correction has happened, it’s generally too late to react at an overall strategic level. Small tweaks can be made to things like the source of the income, but it is vital that an appropriate investment and income strategy has been implemented from the outset.
It is equally important that you stick to your strategy by proactively reviewing and rebalancing regularly based on the future cash flows that you expect, with some resilience built in for the unexpected.
As always, it helps to be disciplined, stick to the plan, and have a long-term mind set! Your annual review with a CERTIFIED FINANCIAL PLANNER® can give you the feedback that helps you to stay on track.
By Cameron McCallum, CFP® CA(SA)
