Spotting signs of trouble in a retirement portfolio
With Barry Lucas, Financial Adviser
“Retirement planning can be complex, and sometimes even the most obvious risks to a portfolio are more common than you may think,” says Barry Lucas, Financial Adviser at Soundbridge’s Mackay branch. “In these challenging financial times, it’s worth taking a closer look at your portfolio to make sure everything is on track.”
Two potential areas of trouble in a retirement portfolio in the current climate are a concentration of risk around property, and accelerated draw-down of retirement assets due to low yields on offer on fixed income.
“One particular area where we often notice concentrated risk in retirement portfolios is in residential property, both specifically within self-managed super funds, and also as a large component of the total assets of many people entering retirement,” says Barry.
The impacts from COVID-19 are yet to be seen in a property market context as transactions generally follow a due diligence process and are less liquid than the public market of the stock exchange. High unemployment rates, increased lending risk and credit tightening are all looming as roadblocks to a recovery. The residential property market could also be hurt by ongoing travel bans and possible restrictions on immigration. Although investors with a long horizon can take this kind of volatility in stride, retirement investors should be very cautious about the sequencing risks associated with these kinds of market events. On the flipside, there are opportunities on the horizon, if you know where to look.
Low cash and fixed incomes yields
Another point of concern is the effect of a low-yield world on retirement incomes. Retirees are having to draw down on their asset base in order to generate income from certain asset classes. This is a particular problem in the current economic climate and needs to be taken into consideration, given the likelihood that the current low-yield rate will continue for some time to come.
Similarly, cash exposure must be carefully managed to ensure inflation and financial repression don’t eat into your asset base. There’s also the issue of longevity risk to consider. You should plan to live long and better while also managing your assets to cover the eventuality that you do live until a very old age. Retirement investors don’t want to outlive the value of their portfolio.
Key considerations: retirement versus accumulation
Says Barry, “There are several key differences to consider between investing during the retirement phase as opposed to the wealth accumulation phase – the two have distinct needs and profiles. It’s important to understand the different needs and goals of each phase.”
In the accumulation stages, the investor is typically contributing towards their superannuation and at the same time making other investments outside that portfolio. The principal goal is growth, with the aim of reaching retirement with the largest possible portfolio of assets.
In retirement, investors will need to think a little differently.
The first consideration is their tax situation. In retirement, investors will likely be in a lower tax bracket than they were through the accumulation phase, and with that comes a number of advantages. In retirement phase, franking credits are worth much more, and that has the potential to generate a large income from the equities and hybrid components of a retiree’s portfolio.
Secondly, investors must consider longevity and the risk of outliving their asset pool. Portfolios in the retirement phase are typically more exposed to fixed income, and potentially cash and more conservative assets. The income from many of these asset classes is currently quite low, and expected to stay low for some time.
In order to prepare for the possibility of living a long life – or leaving a financial legacy for family members – investors might need to consider their allocation between more conservative asset classes and other assets that have the potential to generate higher income in the current climate. This may help investors to retain sufficient equity in their portfolios so that over time they can draw down on their asset base as well as invest for the future and generate some capital returns in their retirement.
Finally, investors should keep a close eye on valuations, and how they relate to yields across different asset classes, and be prepared to adjust their allocation over time in accordance with changes in these relationships.
Everyone has 20/20 vision in hindsight, but consulting a financial planner can help you to identify signs of trouble in your retirement portfolio and put effective strategies in place to minimise your risk.
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Posted on October 1st, 2020