Retirement Corner :
Investment strategies for retirees and near retirees
To many of today's soon-to-be retirees, saving and investing wisely is only half the challenge when it comes to ensuring a secure future. The second half is just as daunting i.e. figuring out how to generate steady and reliable income from a portfolio, without the risk of running out of money. Striking the right balance between income and growth has never been an easy task, especially with the current inflation rate of 6%. True, many retirees will be counting on their provident funds and may be, one day, retirement benefits from Social Security Fund but given the small average balances of these funds, the current generation of retirees will have to dip into their “other” personal savings more than ever before. In this column we will show you how to make your money last a lifetime with a few key investment strategies. The marvel of modern medicines introduces a whole new piece of the retirement puzzle: longevity risk, the risk that you will outlive your savings, especially in a high inflation environment. It was not that long ago when people used to retire for 10 years or so before keeling over. But now they are retiring earlier, living much longer and face 20 years or more in retirement. As life expectancies increase, so does the amount of time you are likely to spend in retirement. According to the Social Security Administration in the U.S. if you and your spouse retire at 65, there's a 25% chance that one of you will live to age 95. That means you should still be investing for the long term well into your 70s. Funnily enough, “single” people of both sexes tend to die younger. (See Chart 1). Chart 1 How Long Will You Live?
Coming up with a strategy to make a nest egg last for two or three decades has become more difficult because the outlook for many income producing investments is so bleak. While retirees have traditionally relied on a diversified portfolio of bonds for the money they need to live on but in a negative “real” interest rate environment like now, the yield on 17-year government bond is only 5.9% compared to the current inflation rate of 6%. Therefore, relying on fixed income alone will not be enough to live on no matter how large your retirement savings are. Inflation will take big bite out of your living expenses down the road, especially at the current rate of 6%. Thus the burden on people retiring right now is quite large and leaves no room mistakes, because it is almost impossible to recover once you are in the mode of tapping your savings. Total Return Portfolio One strategy to consider in stretching your retirement savings to last your lifetime is to focus on total return rather than how much “income” your investments can generate. Your total return includes the capital gain on your stocks, as well as dividend and interest income from your debt instruments. This so-called total return portfolio typically comprises of a core allocation to local and international equity- 50% or more at age 65, which gives your portfolio the growth it needs to last 30 years or more and to offset longevity and inflation risk. As for current income, there are a couple of instruments that can be mixed and matched to suit your needs such as:
Before you decide what investments should go into your retirement portfolio, it is important to start with how you manage your income. The pie chart below (Chart 2) represents the different uses of your assets during retirement. How much of your portfolio is allocated to each area will be based on your individual needs and goals:
Funding Your Retirement
Previous generations of retirees could shift their entire portfolio to income. However, a 30-year retirement requires you to regularly re-evaluate the balance between growth potential, protection, and actual income, to help you assets outlast you. Listed in the chart below (Chart 3) is an example on how you can shift you portfolio for evolving retirement needs, with products generally falling into the following categories based on their primary characteristics: Chart 3
Growth: Provide historically greater returns, though usually with higher risk, such as equities and commodities. Ultimately, these investments help you maintain accumulation potential within your portfolio so that your assets can both potentially outpace inflation and last longer than you do. Their more variable nature may make them better suited to variable expenses rather than depending on them for your current fixed expenses. However, their greater growth potential makes them essential for maintaining the buying power of your income for your fixed expenses in the future.
Liquid: These products provide easy and quick access to your assets and generally have lower risk and returns such as bank deposit, short term government bonds and money market funds. They are traditionally used for emergency funding either financial or medical.
Fixed: These types of investments and products provide fixed, stable returns overall – bonds, for example. Although, they can be subject to some risks but overall they are good sources for fixed expenses and may be appropriate tools for more conservative investors seeking wealth transfer.
Investment strategies for retirees and near retirees
To many of today's soon-to-be retirees, saving and investing wisely is only half the challenge when it comes to ensuring a secure future. The second half is just as daunting i.e. figuring out how to generate steady and reliable income from a portfolio, without the risk of running out of money. Striking the right balance between income and growth has never been an easy task, especially with the current inflation rate of 6%. True, many retirees will be counting on their provident funds and may be, one day, retirement benefits from Social Security Fund but given the small average balances of these funds, the current generation of retirees will have to dip into their “other” personal savings more than ever before. In this column we will show you how to make your money last a lifetime with a few key investment strategies. The marvel of modern medicines introduces a whole new piece of the retirement puzzle: longevity risk, the risk that you will outlive your savings, especially in a high inflation environment. It was not that long ago when people used to retire for 10 years or so before keeling over. But now they are retiring earlier, living much longer and face 20 years or more in retirement. As life expectancies increase, so does the amount of time you are likely to spend in retirement. According to the Social Security Administration in the U.S. if you and your spouse retire at 65, there's a 25% chance that one of you will live to age 95. That means you should still be investing for the long term well into your 70s. Funnily enough, “single” people of both sexes tend to die younger. (See Chart 1). Chart 1 How Long Will You Live?
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Coming up with a strategy to make a nest egg last for two or three decades has become more difficult because the outlook for many income producing investments is so bleak. While retirees have traditionally relied on a diversified portfolio of bonds for the money they need to live on but in a negative “real” interest rate environment like now, the yield on 17-year government bond is only 5.9% compared to the current inflation rate of 6%. Therefore, relying on fixed income alone will not be enough to live on no matter how large your retirement savings are. Inflation will take big bite out of your living expenses down the road, especially at the current rate of 6%. Thus the burden on people retiring right now is quite large and leaves no room mistakes, because it is almost impossible to recover once you are in the mode of tapping your savings. Total Return Portfolio One strategy to consider in stretching your retirement savings to last your lifetime is to focus on total return rather than how much “income” your investments can generate. Your total return includes the capital gain on your stocks, as well as dividend and interest income from your debt instruments. This so-called total return portfolio typically comprises of a core allocation to local and international equity- 50% or more at age 65, which gives your portfolio the growth it needs to last 30 years or more and to offset longevity and inflation risk. As for current income, there are a couple of instruments that can be mixed and matched to suit your needs such as:
- Dividend-paying stocks (* both local and offshore) give you the best of both worlds: a dividend payout for income and the growth potential in the value of the stock.
- Government and high-grade corporate bonds* reduce volatility and generate some income. The best way into the bond market for most investors is through mutual funds, which give you diversification, liquidity and professional management.
- Real estate investment trusts or REITs, provide a high current income and the potential for appreciation over time. However, some of the on-shore “property funds” tend to be highly illiquid, therefore it is prudent to make sure that your portfolio is sufficiently diversified both on-shore and overseas. REITs typically hold large portfolios of commercial real estate and offer investors dividend payments plus appreciation of principal. REITs tend to rise and fall independently of the stock and bond markets, which helps diversify your overall portfolio and over the long term, their total return is comparable with that of stocks.
- Treasury Inflation-Protected Securities or TIPS, although not yet available in Thailand but these are bonds that grow in value with inflation. TIPS are issued by the US Government in 5,10 and 20-year maturities, and guarantee a return that beats inflation. For example you invested USD 1,000 at an interest rate of 2% and the current inflation rate is 3%. Your principal would rise in tandem with inflation and be valued at USD 1,030 at the end of the year, plus the bond would pay you 2% in interest on the USD 1,000. The second year, your 2% payout and inflation adjustment would be based on the USD 1,030, and the compounding would continue for the life of the bond.
- Commodity as an asset class is an ideal investment in a rising inflation and interest rate environment. Like REITs, commodities have very low correlation with stocks and bonds, offering diversification benefits with highly attractive return over the long haul.
Before you decide what investments should go into your retirement portfolio, it is important to start with how you manage your income. The pie chart below (Chart 2) represents the different uses of your assets during retirement. How much of your portfolio is allocated to each area will be based on your individual needs and goals:
- Variable expenses – usually include travel, leisure activities, gifts, etc.
- Fixed expenses – include mortgage/rent, utilities, monthly healthcare and recurring bills etc.
- Wealth transfer – assets designated for your family or foundation.
- Healthcare assets – cover any expenses beyond routine prescription such as emergencies and long-term care.
- Emergency/opportunity funds – are immediate cash for emergencies you may face or financial opportunities you want to explore.
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Funding Your Retirement
Previous generations of retirees could shift their entire portfolio to income. However, a 30-year retirement requires you to regularly re-evaluate the balance between growth potential, protection, and actual income, to help you assets outlast you. Listed in the chart below (Chart 3) is an example on how you can shift you portfolio for evolving retirement needs, with products generally falling into the following categories based on their primary characteristics: Chart 3
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Growth: Provide historically greater returns, though usually with higher risk, such as equities and commodities. Ultimately, these investments help you maintain accumulation potential within your portfolio so that your assets can both potentially outpace inflation and last longer than you do. Their more variable nature may make them better suited to variable expenses rather than depending on them for your current fixed expenses. However, their greater growth potential makes them essential for maintaining the buying power of your income for your fixed expenses in the future.
Liquid: These products provide easy and quick access to your assets and generally have lower risk and returns such as bank deposit, short term government bonds and money market funds. They are traditionally used for emergency funding either financial or medical.
Fixed: These types of investments and products provide fixed, stable returns overall – bonds, for example. Although, they can be subject to some risks but overall they are good sources for fixed expenses and may be appropriate tools for more conservative investors seeking wealth transfer.