If you are like many investors, you may see retirement as the end of a long financial journey. After all, you’ve been saving your hard-earned money for so many years to get to retirement, right?
Not quite. The goal is not just to get to retirement – it’s to get through retirement. Retiring doesn’t mean much if you do not have the funds needed to live a long and comfortable lifestyle. While this may seem like a semantic argument, it’s actually an important distinction.
When you view retirement as the end goal, there is a temptation to stop investing once you reach your goal. Many people move their money into investments that are perceived as being safe, such as bank accounts or other cash instruments.
It’s easy to see why that would be tempting. You’ve saved your entire life to reach retirement; the last thing in the world that you want to see is your savings being wiped out by market volatility. If you move your money into a “safe” investment, you avoid that volatility.
There is a problem with this logic, though: it’s very likely that you could live for decades after you retirement. Indeed, people are living so long these days that it’s very possible that some people will spend more time being retired than they did working and investing.
While those “safe” investments may not have much volatility, they also do not offer much in the way of return – the trade-off between risk and return that frames nearly every investment decision. If you want to play it safe, the cost of that safety is potential return.
Inflation: The quiet retirement-killer
You may think that you do not need any return in retirement. You have reached your goal; why do you need to keep making money? Is safety not more important than growth?
The truth is that it is essential to continue to grow your savings in retirement. Inflation affects nearly every aspect of your life, from groceries to transportation costs to health care. There is simply no way to avoid the steady increase in cost of living; and as such you need investment growth to combat that inflation.
Let’s consider an example. Assume that you retire with £1,000,000 and you plan to withdraw £50,000 each year for living expenses. If your funds were in a safe investment and had no growth, that income would last you 20 years.
However, there is no way that you could comfortably live on the same amount for 20 years; over time, that £50,000 would less and less spending power. You would be forced to withdraw more every year to pay for higher-priced milk, fuel, medical costs, and other basic necessities. In this “safe” example investment, assuming inflation was 2.5% every year, your savings would only last 17 years. If inflation were three percent, your savings would only last 15 years.
Safety is important, but so is growth. The fundamental problem in retirement is how to balance the two.
How to manage your investments during retirement
The instinct to move towards safer investments is correct, but should not be taken to the extreme of moving into cash and other low-return instruments. The wise approach is to shift your allocation gradually to safer investments over time, giving you a blend of low-volatility assets and those that generate high returns.
One simple approach is to use your age as a measuring stick. Subtract your age from 100 and use that number to determine your shares/funds exposure. If you are 65, put 35% of your portfolio in shares/funds and the remaining 65% in bonds, cash, and less volatile assets. Also worth considering are structured products which allow individuals to receive a decent level of income – many deVere clients have received returns of up to 63% over a three-year investment period – without taking what most experts would consider to be excessive risk.
A more nuanced approach, though, would be to consider what you need from your investments, especially relative to your income. If you have a generous pension, perhaps you do not need income from your investments. Maybe they are to be used in an emergency or simply to pay for travel and other big-ticket items. In that case, you may be able to afford more volatility.
On the other hand, maybe you need regular income from your investments. Perhaps you need to sell shares, bonds, and other assets regularly to maintain your lifestyle. In that case, more caution may be needed.
The key is to work with a financial adviser to develop an action plan. An adviser can help you determine your goals and align your investment strategy with those goals. They can then regularly review the plan with you and make adjustments where needed.
My experience is that retirement is not – and must not be – the end of the financial planning process; it just marks a shift in strategy.
For more information on investing in retirement view my recent blog “Pound Cost Ravaging – The beast that can destroy your pension pot.”
Blog published by Mike Coady