A common personal finance trap is to concentrate on saving and investing to finance our eventual retirement without thinking enough in advance about how to invest and spend that money in retirement.
Given that we have so much going on in our lives long before retirement –such as our careers, dependent children, home mortgages and trying to save – this focus on accumulation is understandable. But it’s only part of the equation.
It makes sense to begin developing smart retiree spending and investing strategies long before retiring. This should help you think about what are your personal and investment goals as a retiree and how much you need to pay for those goals.
It’s working out the destination and deciding how to get there.
Aiming to save a certain total amount before retirement is obviously valuable, but you should also think about what the capital will eventually provide in terms of retirement income and, critically, how to invest that money. In turn, this may prompt you to step-up your retirement savings.
At the beginning of their final 10 years or so in the workforce, many forward-thinking investors would begin to think more about developing thorough retirement spending and investing strategies. Importantly, they may still have the ability to boost their savings if necessary.
In turn, this count-down stage to retirement is one of the times when a skilled financial planner can be most valuable.
The combination of historically-low yields, expected muted investment returns and growing life expectancies are high among the incentives for retirees to become smarter with their drawing down, investing and spending of their retirement savings.
“The need for retirees to implement informed portfolio spending strategies is more critical, and yet more complex than ever,” comments a Vanguard research paper, From assets to income: A goals-based approach to retirement spending*.
“For retirees, the stakes are high,” the paper adds, “and the impact of subpar decisions can be severe.”
As the paper’s authors say, there is no one-size-fits-all strategy for developing and implementing a spending strategy because every retiree’s circumstances are different to varying degrees. However, a spending strategy can reduce the “anxiety and stress” regarding the ability of retirees to meet their retirement-income goals – no matter their circumstances.
Many Australian retirees will have, of course, a combination of super and non-super savings with various tax consequence, further underlining the need for good professional advice.
The goals-based spending strategy discussed in this Vanguard paper has three primary components:
This involves dealing with your competing goals – including differentiating between needs and wants – and planning to make your savings last given uncertainty about life expectancy and movements in investment markets, which are beyond an investor’s control.
A critical issue here is how much can retirees “safety” withdraw from their portfolios each year to finance their current spending and to generate future income for the rest of their lives, no matter how long.
Vanguard’s paper suggests a “dynamic-spending rule”. This provides for retirees to set a maximum and a minimum for their annual spending limits – in other words, a floor and a ceiling – reflecting the performance of the markets and a retiree’s unique goals.
The next Smart Investing looks closely at the dynamic spending rule with its ceiling and floor on annual spending based on percentages of a portfolio’s value.
Retirees can aim to spend a higher percentage of their portfolio’s value when markets have done well and reduce spending to a lower percentage – within these set and acceptable limits – when markets haven’t done as well.
In line with Vanguard’s principles for investing success, this involves setting clear and appropriate investment goals, developing an appropriate and diversified asset allocation, minimising investment costs and maintaining a disciplined, long-term and non-emotional approach to investing.
As the paper explains, taking a total return approach to investing and spending can make much sense for retirees. This involves focuses on both the income and capital growth generated by a portfolio rather than merely on income. Total-return approach should help a retiree maintain a portfolio’s diversification, allow more control over the size and timing of portfolio withdrawals and increase a portfolio’s longevity.
Retirees can potentially increase their spending amounts and the longevity of their portfolios by making their investing and withdrawing from super and non-super portfolios as tax efficient as possible. (A superannuation fund is not taxed on assets backing a pension, excluding a transition-to-retirement pension. Nor is the pension income taxable in a retiree’s hands.) Tax is among the areas where professional advice can be vital.
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* From assets to income: A goals-based approach to retirement spending, September 2016, by Colleen Jaconetti, Michael DiJoseph, Zoe Odenwalder and Francis Kinniry.
Written by Robin Bowerman, Head of Market Strategy and Communications at Vanguard.
Reproduced with permission of Vanguard Investments Australia Ltd
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