According to RaboDirect’s latest Financial Health Barometer, more than 50 per cent of Gen Xers and Baby Boomers believe they will run out of funds in retirement and will be forced to rely on the Aged Pension. In this article we show you how to make the most of your retirement savings and reduce some of those concerns by smart portfolio management.
Fear of running out of savings
A bad choice of investment can be a serious wealth destroyer, but as much as it matters how much you lose, when the loss occurs it can make a bigger difference. As you approach or enter your retirement, a decline in the value of your portfolio can be especially devastating. For many, you will be making your biggest contributions in those final years before stopping work, and so any drop can hurt even more than expected. This is called sequencing risk, where a drop in value in the early years can take a decade to recover and hurt the long term sustainability of an income stream.
If you’re in the income stream phase of retirement and are taking funds out of your portfolio, what you run up against is the phenomenon of ‘reverse dollar cost averaging’.If you are taking out $5000 a month to help cover your retirement living expenses, and you have to sell shares during a financial downturn, you’ll need to sell more of them, which means you won’t be holding them when they recover. Sales like this can cause you to run out of money quicker.“A bad choice of investment can be a serious wealth destroyer” That is why we advocate the use of a ‘three bucket strategy’in retirement. Better yet, you can implement and monitor most of this strategy yourself.
1. Short term bucket – security bucket
This phase lasts for the first six to 12 months of pension payments in 100 per cent guaranteed return investments.
2. Medium term bucket – income focused bucket
This phase covers the next two to four years of pension payments.
This can include long dated term deposits, government and blue chip corporate bonds, property for income, infrastructure, or paying regular income.
“Every year, you need to review all three investment buckets in your portfolio”
3. Long term bucket – growth bucket
For the long term, invest in shares, property and other growth assets which are designed to perform longer term.
The purpose of the strategy is so that if a financial crisis hits you will have five years cash and fixed interest to pay the pensions and five years for the growth assets to recover before looking at selling any to fund future pensions.
Every year, you need to review all three investment buckets in your portfolio. The amount of money in the cash/security bucket will have been supplemented by the income earnings from the other two buckets, but you may still need to rebalance your portfolio.
The objective is to maintain a minimum of 12 months’ pension payments in the cash/security bucket and one to two years in the medium term bucket which holds income orientated investments while the growth bucket takes more risk for a better long term return. Any positive earnings in either the medium or long-term buckets go into the cash bucket but if the long term investment bucket that has dropped in value it remains untouched for that year to allow it to recover.
The bucket strategy allows you to ensure that money is held in the most appropriate sectors for different funding needs and that you only tie money up in illiquid or volatile investments if they are not needed for five years or more. This also gives protection for market downside as you do not need to access money that has reduced in value immediately giving it time to recover before any draw down.
Disclaimer: The views expressed, and any advice given, in the above article are those of the author, and do not necessarily reflect the views of RaboDirect. We recommend that you seek professional advice before making any decisions relating to the matters discussed in the article.