As a retiree, your finances are at their most vulnerable at the point when you retire. At this time, there is significantly less money being contributed (if any) and the value of your portfolio relies heavily on the investment returns received. If these returns are poor in the early years following retirement, it can have devastating effects on your portfolio. Keeping a close eye on your retirement assets and altering your investment decisions and retirement goals in the early years can significantly change your future financial position for the better.
Rules of thumb for retirement
Russell has a number of 'rules of thumb' when it comes to retirement decisions. Although personal circumstances may vary, the $20 rule of thumb is a guide to how much income you can expect from your retirement savings. Based on a retirement portfolio of 35% shares and 65% fixed interest, every $20 of retirement savings generates $1 of retirement income per year. For example, if you have saved $400,000 for your retirement, you can expect to receive an income of around $20,000 each year. The following diagram shows the retirement income from a range of different saving levels.
Compare your total amount of savings at retirement to the projected annual earnings available to you throughout retirement.
The other rule we commonly refer to is the Russell 10/30/60 Retirement Rule. This rule outlines that, from a portfolio of approximately 35% shares and 65% fixed interest, the sources of your investment earnings during your retirement could look something like this:
- 10% from money you saved during your working years
- 30% from the growth of your savings before you retired
- 60% from growth that occurs during your retirement
In other words, as much as 90% of your investment earnings during retirement can come from growth, and a significant majority of that growth can take place after you retire. Consider the following chart that shows the relative scale of contributions during your working life compared to investment earnings pre and post retirement.
Poor performance in the early years can have devastating effects
These rules have proven true over many different timeframes and periods of different investment performance. However, retirees' portfolios are at their most vulnerable in the years immediately following their retirement. If poor or negative performance is experienced in these early retirement years, these rules can be tested.
Consider the following example. John has $700,000 in his retirement savings when he retires at age 65. He decides to withdraw $50,000 each year from his savings to fund his retirement (indexed each year to inflation). On the following chart, the bars show the earnings received by his portfolio each year. The line shows the balance of his portfolio each year. We have assumed the returns he receives are based on the returns experienced by a balanced portfolio over the past 20 years (with the last year of the chart corresponding to the returns received in 2009).
You can see that John is able to maintain his income each year, and at this rate, his portfolio will last at least 20 years (or until he is 85). This is his current life expectancy. If he lives longer than this, we estimate that he still has around $350,000 which he could use to purchase a lifetime annuity.
Source: Russell Investments. Super Ratings median Balanced Fund real returns 1990 – 2009. Past performance is not an indication of future performance.
However, consider what happens if John's portfolio experiences very poor performance at the start of his retirement (such as what some retirees have experienced in the past couple of years). In the following chart, we have reversed the annual performance. Overall the portfolio earns the same total return, but the poor performance occurs in the first 2 years of John's retirement (the first year corresponds to investment returns in 2009).
The balance of John's portfolio is significantly less after only 1 year due to the negative returns, falling from $700,000 to around $400,000. If John continues to receive $50,000 each year, his retirement assets will be depleted after only 15 years. At this time, John may be able to receive the Aged Pension, but his standard of living later in life would be substantially reduced.
Source: Russell Investments. Super Ratings median Balanced Fund real returns 1990 – 2009. Past performance is not an indication of future performance.
Strategies to combat early years of poor performance
As noted in the 10/30/60 rule, the majority of investment earnings for a retirement portfolio actually occur in retirement. So retirees need to be mindful of the impact investment returns can have on their retirement assets. There are a number of strategies that they should consider:
- 'Do nothing' in the early years. Nick Pantu from Prime Time Financial Councillors suggests that retirees do not draw much of an income from their retirement portfolio in the years immediately following their retirement. This 'wait and see' attitude enables the retiree to consider their lifestyle needs and goals based on their actual retirement spending habits, rather than on their pre-retirement expectations. It also gives their portfolio time to 'settle' into a retirement framework, allowing the retiree to make realistic income drawdowns in line with the investment performance that is experienced.
- Consult with an adviser regularly. The 'set and forget' approach to retirement planning can have severe consequences if the investment performance experienced is not in line with the 'projections' received in pre-retirement conversations. Regular meetings with an adviser (at least every 6 months) can help you to maintain realistic goals for your future and adjust your income level or investment allocation.
Take heed of the early warning signs
Unfortunately all the careful planning you undertook before you retired can be quickly undone by periods of poor performance. It is important to keep informed, consult regularly with your adviser and take note of the early warning signs that your portfolio is not keeping up with your income needs. This will mean your retirement assets last well into the future, and help you maintain the retirement lifestyle you have been planning on.
