Picture your first years in retirement. Things are going great. Days spent playing with the grandkids, sunny mornings on the golf course and leisurely walks on the beach - your very own version of nirvana! Before you completely relax into your golden years though, you should be aware of a potential financial pitfall that can be devastating just as retirement begins.
Why the alarm bells?
Because after years of putting money away, you’ve probably got more cash now than you’ve ever had, or will ever have again.
And it needs to last a long time.
The wrong choices (or even some bad luck) around the time you stop working, can be devastating for your longer term financial security.
Fund management giant Prudential recently analysed what happens when a series of negative returns happens early in retirement. Read their report here.
They compared two hypothetical investor portfolios over 30 years. Portfolio A had negative net returns in four of the first five years and positive returns at the end. Portfolio B had all positive returns in the first five years but significant negative returns in four of the last five.
The effect: Portfolio A went to zero in 15 years, and Portfolio B was worth just more than $2 million in year 30.
"The 10 years leading up to retirement and the 10 years after are all risky," said Srinivas Reddy, senior vice president and head of full service investments at Prudential Retirement. "But the five years after when you retire are among the riskiest."
Markets recover. As long as you have time on your side, there’ll be no real damage done.
But what if you’re retired.
You still have to eat. You still have to draw pension payments. You might even have to sell investments to fund those pension payments. And selling when markets are depressed can really play havoc with how long your funds will last in retirement.
You might not think it makes much difference if markets recover in the end. You’d be wrong. Here is a very simple example to explain why.
There are several simple things you can do to reduce your risk during the “retirement red zone”
PRO-TIP 1 - Cash Is King
The simplest and most effective strategy is to have sufficient cash. This allows you to avoid the need to sell investments after a big fall in markets, while you wait for things to turn around.
PRO-TIP 2 - Scale Back Risk
The aim is to lower the chances of big losses on a retirement nest egg. What are optimal levels of risk to accept however? As your superannuation savings will (hopefully for you) remain invested for many years after your retirement, taking too little risk may mean you run out of capital sooner anyway.
PRO-TIP 3 - Pull Your Horns In
Who wants to hear this!!
But this is the perfect time to do a personal stocktake and evaluate what you spend and where. People seem more likely to retire when investments are strong, and this can lead to over confidence.
PRO-TIP 4 - Retire Later
Good grief, that’s even worse!!
But more years to save and less years to drawdown will ensure you’ll have more money at the end. And working longer is not just good for your nest egg, but it’s good for your health too.
Read more here about increasing the odds of living longer.
Check out our 5 Tips for a successful retirement here.
PRO-TIP 5 - Know Your Limitations And Get Help
Working with a good financial adviser will provide you with a retirement framework and the discipline to stick with your plan.
The world’s largest Index fund manager, Vanguard, in this research paper entitled “Quantifying Vanguard’s Adviser’ Alpha”, argues that good financial advice will add as much as 3% to investment returns through effective asset allocation, behavioural coaching and wealth management advice.
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