Business | Investment
Channel Sponsor
Aged pensioner or a person of leisure?
Just because the financial services world seems to host individuals who earn a lot of money, this shouldn't support a belief that there are plenty of "professionals" out there who really know how to plan the perfect retirement income strategy.
- By Sean Kelleher, Special to Gulf News
- Published: 00:14 April 13, 2008
Dubai: Rule one - Just because the financial services world seems to host individuals who earn a lot of money, this shouldn't support a belief that there are plenty of "professionals" out there who really know how to plan the perfect retirement income strategy. There isn't one.
At a time when the entire banking system has lost hundreds of billions of dollars and with most asset classes gyrating all over the place, it has got to be a good time to reflect on the basics. How do you ensure 'bread-on-the table' (or rice or potatoes) when retirement arrives? Put another way, what will you be: an 'old aged pensioner' or, a 'gentleman/woman of 'eisure"? You can influence the choice.
Target date funds
Emerging as an acceptable retirement planning vehicle are the so-called Target Date Funds (TDF's). In the US they are rapidly becoming the most popular choice within self-directed retirement plans; and the UK government, still contemplating asset allocation (risk) within its 'national savings pension plan', are also said to be leaning towards TDFs. While these jurisdictions are not relevant to the UAE , the research that supports the trends almost certainly is.
TDFs are still an emerging concept. However, from the UAE armchair, it is a concept that you can mimic and follow at home or, through your trusted adviser.
They are based on the time-honoured and totally unofficial Rule two - that the proportion of money invested into equities is 100 less the person's age.
Young people should be enjoying equity gyration (cost-price-averaging and all that); while to the seniors amongst us, gyrating at discos and with equities are two dangerous affairs. Forget fashion. You should only do it if you can afford to.
TDFs are usually constructed as fund-of-funds comprising equities, bonds and cash. No doubt, in time, diversification needs might prompt increasing roles for well-diversified alternative strategies and Private Equity funds. Within employer-sponsored thinking, it's the correlated assets of cash, bonds and equities that dominate.
Two more rules should be thrown in here for those doing it at home.
Rule three - Don't forget to get your base currency right. A Euro-thinker investing in dollar TDFs is missing the point on risk-management by exposing the "management" bit to another and more virulent risk: currency risk. If you buy TDFs, buy them in your base currency. Or build them in your base currency.
Rule four - TDFs may well be a good vehicle during those working years, but, 'building retirement strategy' and 'in-retirement' strategy are two different things. The former requires growth and risk supported by the strong probability of funding from income.
The latter receives no funding and therefore needs to produce income with minimum capital reduction. The latter, therefore, needs a heavy focus on guaranteed lifetime incomes against inflation. How you go about achieving this will vary wildly from country to country.
Using TDFs or its underlying approach requires the recognition of three clear stages within retirement income planning.
Stage one - Starting with nothing, other than income. Ideally, this should be when you are young. The ideal time to start is your first wage packet. Consider this: if we live to say 80, retire at say 60 and save for 40 years we might "make it" 40 years of saving providing for 20 years of retirement.
Asset allocation
Unfortunately, that first wage packet is rarely the biggest, and more unfortunately, most UAE-based workers don't start retirement savings with their first wage packet. Far too commonly, we are looking at 20 years of savings supporting twenty plus years of inflated retirement income. Don't shoot the messenger!
Getting the asset allocation right in stage one is critical as is teaching savers to accept a high proportion of equity risk. Where else can the growth over time come from?
According to Zvi Bodie at Boston University, "Empirical evidence suggests that TDF strategy should be an improvement over the choices currently made by many uninformed plan participants [self-directed retirement savers]. Research studies have shown that many employees choose to hold far too much of their retirement savings in the shares of their own company (undiversified) or in short-term money market accounts [low rate of return and not really safe as a long term investment]".
The educated approach is likely to revolve around a growth strategy which recognises risk and volatility. With the extent of that volatility contained within parameters based on the savers attitude to risk (tolerance to loss).
In the US, the TDFs have been cleared as "qualified default investment alternatives". The significance of this is that a significant amount of fiduciary responsibility for performance is removed from employers. They are a "safe harbour" for employers against lawsuits filed by employees claiming under-performance.
Pre-retirement
The real value of the TDF-approach is the management of assets (based on age) featuring the reduction of the equity exposure. This process leads to the recognition of Stage two - Pre-retirement. The challenge here is to ensure that the timing is managed appropriately. Selling a 10 per cent stake out of equities just because it's your 50th birthday isn't all that logical. The need for a fund manager to operate the process on an active basis is therefore important.
From a planning perspective, 'Stage two' is frequently tough. It needs to include "human" decisions. If the assets perform badly, or the saver hasn't saved enough; can the employee work longer and save more to compensate?
Getting this right makes the risks of the next stage of retirement drawdowns less risky.
Stage three - During this stage there are three risks dominating your classification as either an 'old-age person' or a 'gentleman/woman of leisure', that is, your standard of living.
Risk one - Market risk. Asset allocation is as important now as ever. Income production and capital protection being more dominant than equities.
Risk two - Inflation, the biggest enemy to the static income. And finally Risk three - Living too long, which can be offset by dying too soon and a decent life insurance policy!
The writer is chairman of Mondial Financial Partners.
Share this article
More from Investment
More from Business
Popular in Business
-
Budget travel
Airlines in the region
Take a pictorial look at some of the budget airlines in GCC
Business Editor's choice
-
Journey of UAE's own label owner
Sky is the limit for Rais who has renowned Djs signed to his firm
-
Global Village
Revamped layout featuring four cultures to greet visitors this season
-
UAE's bounced cheque law explained
Senior lawyer Hassan Arab explains court's take on bounced cheques
