Despite the recent wild ride for markets coping with the uncertainty of the coronavirus pandemic, many investors are well-versed in the need to “sit tight”.
They understand that moving out of positions in falling markets risks crystallising losses at the bottom and missing out on the recovery.
For retirees it’s not so simple, where portfolios are particularly vulnerable to sequencing and behavioural risks that are not so apparent for those in the accumulation phase. If investors continue to contribute to their super fund in the current environment, they are potentially buying into the market at bargain prices every time they receive their salary.
Gains might take some time to materialise and losses some time to overcome, but with a long-time horizon there is more opportunity for an investor’s portfolio to recover.
If, on the other hand, investors draw down on their portfolio they may experience the sharp end of sequencing risk. Losses affect the entire nest egg, a proportion of which will be invested in assets acquired at higher points in the market cycle. In our view, most retirees have less of an opportunity to buy back in and take advantage of the future upside to current low prices. Crucially, most also have no choice but to draw-down to fund their costs of living – meaning they have to liquidate positions in a falling market.
Watching the dollar value of their life savings fluctuating over the course of a single day can be gut-wrenching for retirees, and these emotions are compounded by the ongoing health and societal crises raging around us. The fight or flight instinct is very strong in times like these. In our view, it creates a very strong behavioural risk for retirees who may act against their own best interests by switching out of growth assets at the worst possible time to “protect” what remains of their nest egg.
Shoring up your position without selling the silverware
These two risks create a conundrum for the retiree. On one hand, there is an imperative to reduce their exposure to market falls in order to minimise sequencing risk, and on the other hand there also exists a significant behavioural risk in shifting to lower risk asset classes at this point in time. It’s a tough time to make a decision but investors should be aware of the options available to them.
Diversify into other value assets
We believe one way to manage risk and lower an investor’s exposure to falling equity markets is to diversify. The key at the moment is to look to other asset classes where discounted pricing might be available, diversifying into areas such as infrastructure, property, credit and other alternatives.
There are a number of funds and products offering forms of protection for capital or income. Investors retain some level of exposure to market gains, but could also be insulated from more significant losses to their portfolio.
Research shows that one of the most powerful tools retirees have to secure the stability and sustainability of retirement income is to know how much they can safely spend. This depends on many variables such as age, health, social security, wealth – to which a financial advisor can guide retirees. It also might surprise retirees that even a large fall in markets may only require a small adjustment in weekly expenditure to ensure their retirement income lasts.
Reconsider what is ‘defensive’
The traditional approach to retirement investing is to move further into traditional ‘defensive’ assets such as cash and bonds. We would like to emphasise that while these assets in the short term have the least likelihood of a negative return and therefore could be considered ‘safe’, the future returns of cash and bonds are relatively low. A large allocation to this group may reduce long term returns and jeopardise the sustainability of a retirement income strategy.
Investors stand to lose when they move a large proportion of their assets to defensive positions such as cash and bonds in the current environment, locking in lower returns for their portfolio. It may feel comfortable in the short term, but over the long run it could seriously jeopardise the longevity of their retirement income.
We believe an investor could improve their retirement strategy over time by considering the steps above and always on the basis of sound financial advice.