The popular investment rule of thumb “time in the share market- not trying to time the market” does hold some truth. However, it does not help to alleviate what is called sequencing risk, one of the major post retirement factors that can impact your retirement lifestyle.
What is sequencing risk?
When you are approaching retirement, or have just retired, a sequence of poor returns can have a devastating impact on your retirement savings. This is in contrast to when you are accumulating your wealth over many years and the sequence of returns does not matter to such an extent. The Global Financial Crisis (GFC) highlighted that if there is a downturn or correction in investment markets, the majority of assets classes decline at the same time. During the crisis, if you were about to commence drawing down on your retirement savings, or were already in the pension phase, you would have been drawing down on a lower total balance. Investment markets have since recovered from the GFC. However, if you have drawn down on your retirement savings in the meantime, the balance will not return to the levels they were before the GFC.
Why is it important to reduce sequencing risk?
The recent Intergenerational Report has highlighted the increasing pressure mounting on the Federal Government to fund the age pension. This is reflected in the recent changes to the age pension asset test announced in the last budget. Retirement projections are made based on average investment returns. However average returns are rarely experienced and are more likely to be less than or more than the average over a short period of time. If you experience below average returns leading up to retirement and in the early phase of retirement, the fund balance is not likely to last as long as forecast. A high allocation to growth assets is required to offset post retirement risks such as ‘longevity risk’ and ‘inflation risk” . However, it does increase your exposure to volatility and the potential for sequencing risk.
Strategies to overcome sequencing risk
- Withdrawal Rates
Consider combining different withdrawal strategies to target specific needs. For example, you may use an inflation adjusted withdrawal amount to cover your essentials and a fixed percentage withdrawal (which will fluctuate depending on investment earnings) to meet your discretionary expenses. FINSIA has published safe withdrawal rates based on a number of factors that maybe used as a guide depending on your circumstances.
- Plan to live to 100
Most retirement planning is based on average life expectancy. You or your partner may live 10 or more years beyond that. Planning to live to 100 and saving accordingly, will help you accumulate sufficient funds to reduce the potential impact of sequencing risk. By focussing on the right number you need for retirement you will be able to start saving earlier and let the benefits of compounding start to work.
Australia’s taxation system encourages investment in property and in particular our principal place of residence. This results in property prices in Australia being amongst the most expensive in the world. You can make a significant difference to retirement savings by making a large contribution to your superannuation. Downsizing your home near retirement to make a one off contribution is one way to free up capital. You may also consider renting out your home whilst you are away to supplement your income after retirement. However, there are taxation issues to consider before exploring these strategies to ensure it is the right decision for you.
- Reduce the cost of retirement
Perth has become one of the most expensive places in the world to live. Your retirement savings may last a lot longer if you could reduce the cost of retirement by living in another country for part of your post retirement life. This may also be a cost effective way to enjoy your ‘Go Go’ years. However, again you need to consider taxation and age pension implications before considering such a move.
- Transition to retirement
If it is possible to reduce time at work down to 4 days then 3 days, it will enable you to take advantage of tax rules encouraging you to work longer and also provide an additional retirement buffer. You might be able to use your additional income from working part time to meet all your living expenses for the years you are in transition and let your retirement savings grow further.
- Investment Strategy
Your “investment strategy” should be reviewed as you transition from one life stage to the next. As you approach retirement, focus should shift to investments that have less volatility and correlation to traditional asset classes. If you have been following a passive investment strategy using index or exchanged traded funds it will be time to consider more active management. The liquidity of your investments will also become more important so that you have flexibility to sell down a partial portion of your portfolio as necessary. 7. Be Happy Planning what you will do in retirement is as just as important as planning the funding of your retirement. What you do with your time will affect how much money you require. If you are happy in retirement, you will less likely experience “retirement remorse” and “grey divorce” which can have a devastating impact on your retirement savings. Preparing a transition plan will assist you in considering both matters of the head (mental) and heart (emotional). 8. Annuities If you are not prepared to take the risk of a share market downturn, it is possible to protect your income/ capital by purchasing an annuity. There is a variety of annuities available offering features for differing circumstances. If you decide that there is certain level of income for example your “lifestyle essential” funds that you wish to lock in, a purchase of an annuity for that portion of your income maybe suitable for you.
Financial modelling of retirement assumes that returns will be average. However, the reality is that returns are rarely average. The sequence of returns that you receive in retirement has a large impact on post retirement planning. Sequencing risk is a potential detractor that may impact your retirement nest egg. Consideration of the strategies described here may minimise the impact of sequencing risk on your retirement lifestyle and provide enough flexibility so that your retirement is a fulfilling and enriching stage of your life. Follow My Footprints – Geoff
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- How to Avoid Grey Divorce
- What is Your Exit Plan?
Disclaimers & Disclosures
Geoff Ivanac is Sub-Authorised Representative No. 000309751 of GPS Wealth Ltd (GPS) ABN 17 005 482 726 Australian Financial Services Licence (No 254 544) and can provide the following services financial planning, risk management, managed investments, superannuation and retirement planning, margin lending and self-managed superannuation funds.
The information provided on this website has been provided as general advice only. We have not considered your financial circumstances, needs or objectives and you should seek the assistance of your GPS Wealth Ltd (GPS) Adviser before you make any decision regarding any products mentioned in this communication. Whilst all care has been taken in the preparation of this material, no warranty is given in respect of the information provided and accordingly neither GPS nor its related entities, employees or agents shall be liable on any ground whatsoever with respect to decisions or actions taken as a result of you acting upon such information.