Financial challenges in retirement

Working life has completely different financial focus and different set of challenges to retirement.

While working your focus is to:

• Build your career
• While growing earned income
• Pay off your home
• Assist and support your children
• Build wealth through superannuation and/or investments outside of super

Once retired, this focus changes to:

• Supporting your everyday needs, therefore there is a big focus on cashflow to meet your required standard of living
• You want to protect your income, so you can spend confidently during your retirement
• you need to plan to ensure your income will last for an unknown period of time, after all we do not know how long we are going to live
• You might also consider potential future need for aged care

Therefore, with your retirement, there is a financial focus shift from capital growth and wealth accumulation to income stability and wealth protection.

But now, when approaching retirement or during your retirement, you are faced with some challenging financial risk, that if not managed correctly, can prove your strategy or lack of it, as being of very high risk indeed.

So today, I would like to discuss the different financial risk factors that you need to take into account when preparing for your retirement and during your retired.

This graph explains the main risks that you need to deal with, plan for and manage correctly when planning for retirement:

• Sequencing risk – the order or sequence of negative returns during your investing years
• Market risk – market performance and its fluctuation
• Inflation risk – eroding purchasing power of your savings
• Longevity risks – as we live longer, it is required to plan for 30 years of longer that your money need to support you in your retirement. So will your money last this long?
• Emotional risk – bad investment decisions made due to emotional response to usually negative market returns or higher than usual volatility.

Australians live longer

As you can see in the graph, the expected number of people aged 65 in Australia in 2030 will be close to 6 million, while in 2070 will be close to 10 million.

That increase is going to be present in each retirement age bracket. And as a matter of fact, the Australian of the age of 65 today has a great deal of chance to live well pass the age of 90.

Therefore, knowing that you might live that long, you really have no choice but to plan your financial savings with management of those listed risks, as we are talking about your money supporting you for a very long period of 20, 30 or even close to 40 years.

Our Average life expectancy is improving:

At birth males are expected to live till the age of 81, but the life expectance expands to 85 from age of 67, and then due to mortality improvements it gets even longer to age of 88.

For females it the same at birth we are expected to live till 85, from age 67, our life expectancy is 88 and due to mortality improvements, it is even longer till age of 90.

Let’s very quickly talk about the sequencing risk.

Nobody likes negative investment returns, but in some years they are just inevitable. But in your retirement years, the timing and order (sequence) of those returns matter and are critical to the quality of your retirement and how long your money will last.

This is the part of advice you are not getting from your super fund, while as you can appreciate it is a crucial part of financial planning for safe retirement with income provided for life.

During your working life, while in the accumulation phase, negative returns at the beginning of your savings journey are actually positive, as you are accumulating those investments at a highly discounted price. But once you get closer to your retirement and you have accumulated a solid level of savings, now you wish for the market to reward you, and you only want positive returns. If this happens, your investments will increase in value dramatically.

This graph shows the same $50,000 investment with $10,000 annual contribution subject to 4% CPI increase:

• Market A – provides the best long-term returns while it had the worst negative returns at the beginning of its run
• Market B – choppy returns all the way
• Market C – good returns to start with and then bad luck of some years with ongoing negative returns and overall the worst performing fund.

In retirement however, you need the opposite to happen. Negative returns at the beginning of your retirement can be detrimental to your overall retirement for life.

If we look into the graph prepared by Challenger, you can see the difference in the outcome. In each case $400,000 was invested in exactly the same portfolio, but with the difference of returns:

• Market A experienced negative returns in first years of running income stream
• Market B had mixed returns, one year positive, next negative and so on
• Market C had few positive years at the beginning of the income stream being set up.

Therefore, you might say that luck play a huge factor in how long your money will last, but this sequencing risk can be managed, and it is not done by your super or pension fund, it has to be your own correct planning as part of your money and financial risk management with the goal of reducing the impact of this sequencing risk on your retirement savings.

And then we have another major money destroyer, inflation.

Take a look at this graph:

Therefore, with the inflation running at 4%, your pension payment of $1,100 today will only be worth $250 (in today’s money) in 35 years. That is a huge reduction in value of the purchasing power of your pension payment.

Therefore, you might say that sequencing risk, market risk and inflation risks are all connected. They are impacting on longevity risk and your emotional risk. 

So, your retirement investing is no longer as simple as your super fund would like you to believe: “Let’s start an account-based pension and you will be OK”. This is just hoping for the best outcome. And with that long life expectancy ahead of us, this is just not good enough.

Your portfolio needs to be more comprehensive.

First, you need to organise the “guaranteed part of your income” that will be delivered to you no matter what happens, irrespective of market behaviours to ensure you can always buy your food and pay your bills. This is the income that covers your necessities, your essential lifestyle needs.

Than the remainder of your income can rely on those market returns. When years are positive, this is your cream on the cake. This is what buys you holidays, luxuries and extra fun things to do. That is the non-guaranteed part of your income that might run out due to those risk factors.

I believe the issue of financial risks is incredibly important, but because of its complexity is not explained, or even mentioned at the crucial time of your preparation for retirement. But it is never too late, just make appointment with us. To do this, visit our webiste AboutRetirement.com.au, on each page there is a button: BOOK A MEETING and then choose the day and time that suits you. During our meeting we can discuss the very issue that needs to be addressed and resolved with proper planning.  

By: Katherine Isbrandt CFP®
Money Strategist & Retirement Planner
Principal of About Retirement