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Investor Series - Hidden Danger Awaits Retirees!

Getting Insync with the Global Downshift

A series of articles highlighting major issues surrounding the next big stage of global development and what it means for investors

One of the biggest risks retirees face when investing is in the first five or so years. It’s called Sequencing Risk. This is when you experience relatively poor returns in the early years for a retirement that perhaps has to span 25-30 years.

It can ruin a happy secure retirement even if starting with the right amount saved. 2008 was a recent example. For those unlucky enough to have retired near this year, the amount you could then live on had to be cut drastically, or face the likelihood of the money running out and living their last years in poverty or being forced to sell one’s home. This doesn’t have to happen. In this article we will look at historic examples and what can be done to mitigate this risk.

Sequential risk can occur no matter what you invest in, including property, unless you take the right precautions. For most people, holding shares of productive businesses is a part of the long term need to earn enough growing income to ensure a secure 2530 retirement - a second lifetime of living. Shares are also the most volatile, and so we will use this asset class in our examples.

Case study - 10 couples retiring

Each couple saved a nest egg of $1 million, investing into the top 500 USA companies– The S&P 500 Index (a similar outcome applies to investing in the Top 200 Australian businesses- ASX 200).

Rising life expectancy means up to 30 years income is required. Each withdraws $100,000 p.a. increasing by 3% p.a. (countering inflation). Fees and taxes are removed as they don’t alter the comparative outcome. Each couple retires one year after the other starting in 1977 (the last couple retiring in 1987).

How did each couple fare?

  • 3 ran out of money well before 30 years simply because in hindsight they retired one year too early or too late.

  • 7 ended well with balances from $500,000 to $3.2 million.

How not to be one of the three. The three that ran out of money retired in 1977, 1981, and 1986. Their ‘average’ returns were still respectable, and compared to those whom did not run out, sometimes achieved even better. So how could they have found themselves in this awful mess? The first five or so years of their investment, returns were subpar. Even though later they did well – better than others whose middle to back end of retirement experienced more mediocre returns.

Insight 1: The perfect storm for retirees is when unexpected catastrophe type losses (-20%+) occur combined with sub-par returns in the early years. You get so far behind it becomes impossible to catch up. It’s known as “sequence of returns risk.”

It’s like an ever decreasing spiral that at each income payment point, more capital is required, which deprives one of that capital in the future to build more income- forever!

The results of the 10 couples in detail:

When analysing the declines in the S&P there were 15 random periods of negative movements of -10.2% to -56.8% lasting from 33 to 929 days. Yet overall average returns were very healthy as we can see in the next table. There is no way to predict who would have been the unlucky 3 and who weren’t. There is no pattern or warning bell. No way an adviser can confidently avoid this happening; but there are precautions one can take.

The long term the S&P500 returned 1.48% more per year for 1977 to 2006; the worst off couple enjoyed this higher average overall return but still ran out of funds. The couple from 1979 to 2008 with the best resulting account balance of all couples averaged a long term return that was actually less than the worst losing couple.

It was the first five years of relatively higher investment returns (and no big losses) that the best couple enjoyed, than the worst couple who retired in 1977.

Insight 2: Be wary of chasing the highest returning investments appearing in league tables. These results are too volatile and can’t be sustained.

What matters is that in the first period of retirement you don’t fall far below the average market return (not trying to vastly outperform it); as well as avoiding catastrophic potholes (the -20%+ variety). On average -20%+ potholes lasting more than 3 months occur once every 6 years since 1965.

No one can predict when falls will last more than a few months or when they will occur. Like earthquakes really. Since 1930 they struck 20 times, 9 lasting over 300 days - the longest 929 days (Year 2000).

Even though the rises over time may provide an average return that appears to be a healthy average; it is the retiree’s need of constant drawdowns during periods of sub-par returns and perhaps the odd pothole in the early years, which interferes with a happy and secure future.

Insync Insight 3: Holding most of your savings in real property won’t shield you from this risk. At some point the rental income alone will not suffice. And even though you won’t need large cash draw down in any one month, you can’t sell just a few bricks; and so the inevitable property sale will have to take place. At this point the whole sequential risk event begins for this portion of your nest egg all over again. Placing it all in cash is an equivalent disaster for longevity of income.

Having your cake and eating it too!

The reality facing retires is they need exposure to large amounts of liquidable growth assets even though the volatility can be damaging. Here is how you can enjoy its benefits and reduce downside sequential risk.

  • Keep 2 years income in a cash fund so you can ride out most periods of low/negative returns.

  • Invest in equity funds that look to produce growing portion of income in their returns

  • Dollar cost average your nest egg in to the retirement strategic portfolio asset allocation (if not already set up in this way)

  • Diversify in ways that produce a smoothing out of returns without giving up too much upside.

  • Downside protect a good portion of your equity investment. Take a closer look at Insync’s investment approach with Global equities as one way to achieve this.

Finally, when retired, holding the highest performers is not as important as smoothing out the inevitable ‘potholes’ across your portfolio. Don’t chase the highest returns, as it increases risks you don’t need. Shielding a nest egg is as crucial to security as posting good above inflation returns. Stellar performers often experience stellar losses. Beware.

All this and more can be found in Insync Funds Management

white paper:“The Unstoppable Global Downshift”

DISCLAIMER: Investment in the Insync Global Titans Fund may be made on an application form attached to the Insync Global Titans Fund Product Disclosure Statement (PDS) which is available from Insync (ABN 29 125 092 677, AFS License 322891) at the web address under the ‘How To Apply’ tab. The information contained in this presentation is general information only and does not take into account your personal objectives, financial situation or needs. Before acting on the information contained in this presentation you should obtain a copy of the PDS and consider the appropriateness of the information in regard to your personal objectives, financial situation and needs before making any decision about whether to invest, or to continue to hold. The repayment of capital and performance in the Fund is not guaranteed by Insync or any other party. Opinions constitute our judgment at the time of issue and are subject to change. Investment guidelines are internal only and are subject to change without notice. Past performance is not an indicator of future performance.

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