Money
Invest, nest or rest: 3 money styles to de-risk retirement income
Worried about rising prices at the supermarket? Do sharemarket ups and downs make you frown? Here’s how to decide which retirement income risk profile suits you best.
By Alex Brooks
Inflation and sharemarket volatility are like bad flatmates – horrible guests who can ruin your retirement income dreams.
Inflation will eat all your food, steal your money for bills and not clean up after itself, eroding the value of what you can purchase over time.
Sharemarket volatility – especially a market slump – can force you to lock in losses that are devastating in early retirement when you don’t have time to play catch up.
These 2 risks can steal the retirement income you planned – quietly, daily, and with compound interest.
But not if you de-risk your retirement income strategy by sticking to a plan.
The less you react by thinking you can ‘sell at the right time’, the better off you might be, according to Ben Le Fort, author of The Rational Investor.
Over time, the stock market – and holding equities, bonds, property or other assets inside the tax-free structure of superannuation – is one of the best ways to beat inflation… as long as you can stare down the headwinds and hold true to your money and risk-taking style.
“Make no mistake, there will be another stock market crash. We just have no idea if it will be in 10 days or 10 years,” he says.
One of the best ways to protect retirement income and future wealth is to ‘know thyself’ by determining your risk profile and investing accordingly. That means holding true to the investor mindset of time IN the market, rather than trying to time the market.
So read on to determine your risk – and risk tolerance.
Retirement income risks: get your head around them
There are a 3 key risks – or unknowns – in retirement income planning:
- Sequencing risk - a market downturn, especially at the time you convert your superannuation into a retirement income account
- Longevity risk - you outlive your money (we cover this in 5 things to know about life expectancy)
- Inflation risk - economic inflation eats away at the purchasing power of your income
There’s no ‘right’ way to handle these risks – only what’s right for you. Ben Le Fort explains that investments need to be made based on credible data and proven results.
He says ‘index funds’ – or exchange traded funds (ETFs) that track the share market or an asset class – are one of the best low cost ways to win over time. And that’s mostly how superannuation works.
Sequencing risk last raised its ugly head during the 2007-2009 Global Financial Crisis (GFC) when Australian superannuation funds lost 21% of their value.
Many Australians aged in their 50s and 60s during the GFC delayed retirement by a few years, and others had to resort to the Age Pension earlier than planned.
There are a few easy ways to mitigate ‘sequencing risk’:
- Delay retirement and continue working - here’s what delaying retirement by 5 years can do for you.
- Create a ‘cash buffer’ or reserve - one that gives you 2-3 years to draw down from money that isn’t tied to your superannuation, thus preventing the need to lock in losses.
- Lock in your long term strategic approach to your retirement income - and stick to it! As Ben says “this isn’t something to set and forget it, you need to revisit it every year to be on track”.
- Check your investing strategy - “Common strategies include underweighting investments in stocks early in retirement or using a portion of your portfolio to buy an annuity in retirement,” says Ben, who has a Substack newsletter where he shares economics research to back up his views.
The solution to mitigate sequencing risk isn’t panic actions – it’s using time to set a plan of how you want to manage risk. And sticking to that plan.
De-risking strategy 1: set, forget, rest
Most of us like to think we are good at picking the market and buying shares or property at just the right time to outperform everyone else – but we’d be wrong.
“The data is clear that people who try to pick individual stocks or engage in excessive trading tend to underperform the market,” Ben says, citing this economics research.
Ben argues that recessions, interest rates or stockmarket crashes are NOT the biggest risk to your wealth – it’s you! People selling down or ‘locking in a loss’ at the wrong time is the single biggest risk to financial independence and retirement incomes.
Time in the market will generally see you maximise returns ahead of people who chicken out and sell everything when the market turns against them.
See also: Shane Oliver’s no-nonsense tips to invest for future wealth and income.
Australian superannuation funds are designed to handle market risk for you – a good fund will have professional investment advisers maximising returns for their pension holders by balancing growth assets, defensive assets and all those other fancy things (even when inflation sucks or the sharemarket gets rocky).
If you want a ‘set and (mostly) forget’ retirement income strategy, then sticking with a trusted super fund for your retirement income stream can be a great option.
A quality fund offers security, good service (and ideally some free advice and education).
It’s up to you whether you go with a basic no-fuss MySuper product (which you can compare in the YourSuper tool) or whether you want to pay a super fund for more features like investment choice, service and advice. You can compare other super funds on the SuperRatings website.
You can even mix and match and accumulate your super with one fund while turning it into a pension or income stream in another.
Benefits of set, forget, rest: Perfect for lifestyle seekers who don’t consider themselves financially savvy.
To-do list for set and forget resters:
- Seek personal financial advice before you plan to ‘decumulate’ your super into a retirement income.
- Diversify your super so you have a mix of asset types – gold, shares, bonds, property – so that poor returns in one might counter strong returns in others.
- Consider drawing down an annuity or fixed income product as part of a retirement income stream.
- Maintain the right insurance (that includes health insurance!) – an unexpected $30,000 hip replacement or cancer treatment can derail a ‘set and forget’ rest strategy.
- Understand the Age Pension and concession entitlements for older Australians and how this fits in with spending down your superannuation. The Age Pension is CPI-linked, so keeps pace with inflation.
De-risking strategy 2: feather your nest and adapt if headwinds blow
For those of us who understand that every financial decision comes with risk – this more active approach to managing your retirement income might suit.
This is usually for people with high levels of financial literacy who understand the ins and outs of sequencing risks and longevity risks.
If you own a mortgage-free property and an investment property (which around 2.2 million Aussies do, according to the Australian Taxation Office) then you might easily fall into this category.
Feather-your-nesters might hold some money inside traditional superannuation but also earn rental income or dividend income from shares held outside of super.
“Investing in stocks through an index fund or exchange traded fund that owns the entire market at the lowest possible investing fees is a tried-and-true method to investing,” Ben says.
Some people with this appetite for risk might also prefer the freedom of a self-managed superannuation fund (SMSF).
Be warned, an SMSF is not for the faint-hearted. It’s plenty of work and you’ll need good accountants and advisors to comply with the paperwork.
Benefits of being a feather-your-nester: With a higher degree of financial savvy, you get more flexibility to earn income in a multitude of ways.
To-do list for feather your nesters:
- Be proactive about avoiding sophisticated scams and fraud that target people with self-managed super funds or trick you into sharing your account details.
- Understand how downsizing at the right time can help you feather your nest - as can moving to a cheaper retirement location.
- Time the way you sell down investments - structuring capital gains tax hits will be key to maximising returns over time, so try to get personalised advice from a professional.
- Review your position every year and adjust your spending in line with returns from investments.
De-risking strategy 3: active investment, ideally with a professional adviser
Australia has something called ‘sophisticated investor rules’ – and we might politely suggest you need to be in this category if you think this is where your risk profile lies.
A sophisticated investor is the type of person who has a high income and assets of more than $2.5 million. It means you’re an investor who can afford to make an extreme loss, so you likely have a raft of good investment advice and accountants and financial planners. (You can also get tax breaks for your investments, too!)
Of course there are many different shades of active investor – you can be 65 and running your own business, 72 and flipping investment properties, or 58 and living off share dividends.
In retirement, these people have the risk profile – and wealth – to ride out any rude market or inflation shocks. They invest what they can afford to lose.
Benefits of active investors: Higher risk-taking can deliver outsized returns in shorter timeframes.
To-do list for active investors:
- Take risks in a calculated way.
- Reposition and recalibrate your retirement income plans every 6-12 months, reviewing your portfolio as you get older and risk attitudes and personal situations change.
- Spend more time managing your money and researching market opportunities than other risk profiles.
Like a good outfit, your approach to retirement income streams should have the right layers for any risky weather that might come your way! A bit of warmth. A bit of stretch. And the ability to adjust if a storm hits.
This article reflects the opinions and experiences of the author and does not necessarily reflect the views of Citro. It contains general information only. It is not financial advice and is not intended to influence readers’ decisions about any financial products or investments. Readers’ personal circumstances have not been taken into account and they should always seek their own professional financial and taxation advice that takes into account their individual financial circumstances, objectives and needs.
Feature image: Canva/gradyreese
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