Near retirement, the ability to handle market risk is to a large extent diminished, and so the obvious preference is to have funds in less volatile assets like fixed-income and cash. But asset allocation for retirement planning has been thrown into confusion in recent years because of increasing life expectancy. People are living for 30 or 40 years in retirement and those who have not adequately planned for this length of time could find their final years a difficult struggle.
Also, a higher cash allocation exposes a retiree to the danger of inflation. In many countries with interest rates at historic lows and inflation stubbornly high, spending power of cash is being eroded more rapidly than ever before.
People need to recognise retirement can last a long time and should be willing to do what is perhaps "counterintuitive to their emotions", says Vince Truong, a US certified financial planner at Holborn Assets, an independent financial advisory firm in Dubai.
What Truong means is people in retirement are more worried about the security of their finances in the short term.
"But if you don't take care of the long term, in other words, if you are unwilling to take risks, your money will run out," he says. "And so, what you have to do then is ladder your risk appetite and your time horizon. So it's wrong actually to just say ‘Let's go into more a conservative portfolio as we approach retirement.'"
Even a few years ago, many advisers would advise clients that the bond/fixedincome and cash exposure in a portfolio should equal their age with the equity component being 100 less than their age. For example, a 65 year old should therefore have 65 per cent allocated to bonds and cash and 35 per cent to equities. This advice is now almost a thing of the past.
"It's over-simplistic, but serves as a point of reference," says Dubai-based Dan Dowding, managing director, Killik & Co, Middle East and North Africa. Today when advising clients, Killik & Co, for example, takes into consideration a vast array of variables such as age, liabilities, additional sources of income such as company pension, income from property, expected inheritances, desired income in retirement and succession requirements, before structuring or adjusting an investment portfolio.
Low rates of interest
"We also have to take into consideration the fact that we have been going through a cycle where people are retiring younger — although this trend will start to reverse — and people are living longer," says Dowding. "Some may need to fund 20 to 25 years [of retirement] from savings and investments — this coupled with an understanding of an individual's attitude to risk, may lead to a higher equity component."
Given the low rates of interest on cash, savers are being forced to look elsewhere for sources of income. This has led many to buy high yielding equities as an alternative, Dowding adds.
"As long as the companies that one is invested in are able to maintain and grow the dividend, it does not necessarily matter what the capital value of the investment is in the short term — in retirement what is key is being able to produce secure an inflation protected income," he adds.
According to Krishnan Ramachandran, chief executive of Barjeel Geojit Securities which caters to Indian expatriate investors of the Gulf, property and equities are an absolute must in terms of a diversification for an Indian retiree. There is no other class of assets that have delivered superior returns than the equities market, he says.
"The 15-year CAGR [compound annual growth rate] on the BSE Sensex [the Indian index] is about 13.20 per cent higher than any other asset class," Ramachandran says. "Over a 10-year period bank deposits have given a CAGR of only 4.6 per cent. Gold as an asset class is emerging only in the last five years and it is too early to take a judgement call on this asset." Ramchandran advises investments be spread over a basket of funds. These include diversified equities, capital protection plans, small and mid cap schemes, monthly income plans, and finally a small portion in liquid funds. The proportion and mix will however depend on every individual and there is no simple formula to this.
"My recommendation will be to diversify within the various investment classes that mutual funds offer, rather than looking at the traditional bank fixed deposit, the most preferred avenue for a majority of Indians. To quote Warren Buffett ‘diversification is a protection against ignorance'."
If not exactly a formula, Truong suggests three separate portfolios for retirement: A cash or cash-equivalent portfolio to take care of the two years' (after retirement) cost of living. Then a moderately conservative, largely fixed income portfolio to take care of the next two to five years. And then five years and beyond, a largely equity portfolio with higher risk that will provide a higher return.
"You live off the safe, short-term money," says Truong. "As it runs out, you fund the short term with the fixed income portfolio. As equities go up and down, you won't care in a sense because the next five years are largely taken care of. As you use up the money from the shorter term portfolios, you then replenish them with the equity portfolios in the years when the stock market is doing well. This is a tiered approach to retirement distribution."
However, in a scenario of a prolonged, long-term bear market, as we have been witnessing it for over a decade now, elongating the respective time spans of the three portfolios is the way to go. "So equities need to have a seven year time horizon," says Truong. If, for example, he says, when people are 65 and in retirement and equities are going down, they should actually be buying in more equities. Ideally, this assumes that they won't be tapping into that for the next five or seven years having taken caare of the short and medium term portfolios.
For a long-term portfolio, he says, one has to take opportunities like the current downturn now to be dollar-cost averaging into the market. But Truong says in a secular bear market, which can last 15 years or more, a buy and hold investor will get low returns because the market essentially trades in a range. "In this type of environment, you must know how to invest actively in a sideways market; you can't blindly buy and hold."
Planning
Truong says his experience suggests that most people have not done this kind of planning. They don't have even the short term or mid-term portfolios saved. In such a situation "one needs to take a conservative approach because you're living off the short-term portfolio only".
A person who hasn't saved and is approaching retirement and who is overexposed to risky assets must start taking opportunities on market upturns to fine tune and de-risk their portfolio, says Truong. That would mean getting out of assets that are inappropriate for the [current] time-frame.
In the prevailing environment, for example, Truong believes that despite America having longer term issues, the US markets and the US dollar are still safe havens. He says he would take these opportunities — the market going up in recent days — to gradually de-risk my portfolio and reallocate towards the US markets. When moving out of a recession, he would prefer to reallocate back towards Asia and emerging markets.
"These days, it's not about stock picking because nearly everything is correlated, moving in the same direction at the same time," Truong says. "It's about where we are on a political and macro-economic level. My asset exposure should reflect that."
Keys to a successful retirement plan
Start early: Key to retirement provision is to start saving as early as possible to give yourself the best chance of accruing a retirement pot which will generate sufficient income in retirement.
The later one commences retirement planning the more they will have to stretch their savings plan. Krishnan Ramachandran of Barjeel Geojit Securities provides an example from India. If people commence at the age of 45 with a monthly savings of (Indian) Rs10,000 they will have approximately Rs4.14 million at the age of 60 assuming a return on investment of 10 per cent per annum. If however they were to start at the age of 55, in order to reach the same target, they will have to save about Rs53,550 per month, nearly five times more. In all probability they will end up with a retirement plan that will take them nowhere.
Research carried out by Price Waterhouse Coopers in the UK recently has shown that for someone retiring today the income generated from pensions is 30 per cent lower than three years ago (before the collapse of Lehman Brothers).
And the latest fall in recent months in stock markets (the FTSE has fallen approximately 15 per cent since May) has in turn boosted government bonds (Gilts), which has driven up the cost of buying a retirement income (annuity) with the pension funds. "Essentially this means that in the current market and economic conditions a significantly higher fund value is required to generate the same level of income," says Sarah Lord, wealth planning director at Killik & Co.
Contribution more important than return: Rather than being caught up too much with the returns of investments, it is prudent to save more and contribute to the plan, say experts. Given the current low interest rate environment maximising contributions is extremely important, says Dan Dowding, managing director, Killik and Co, Middle East and North Africa.
Monitor our portfolio: An investment portfolio should be monitored to get a dose of reality on the investments on different asset classes. "Checking the retirement pot, [against] your goals and benchmarks, is very important," says Vince Truong, a US certified financial planner, Holborn Assets. "If you have done some retirement planning, the plan needs to be updated annually to account for investment performance, life changes, etc. We have to regularly dose ourselves with reality in order to spur action and a regular check up does that." Dan Dowding, managing director at Killik & Co. advises annual or biannual reviews to see if you are on target to meet your retirement goals.
Consult a financial planner: An advisor "can make an arm's length objective decision to buy or sell when our clients find it hard to pull the trigger," says Truong.
"You need that help to do that sometimes. Financial intelligence is often not so much your intellectual understanding of investing so much as it is emotional and behavioural intelligence."
But if you are not working with a financial planner, there are online calculators that can help you plan for retirement. They allow you to input various assumptions and then tell you how much you need to be saving to fund your desire income needs in retirement. "When you see hard figures, when you see how much it really costs to fund retirement and accept the fact that you won't always be able to work, then reality sets in," Truong says. Online calculators such as http://money.msn.com/retirement/retirement-calculator.aspx could come in handy.
Comparison
People commence at the age of 45 with a monthly savings of (Indian) Rs10,000 they will have approximately Rs4.14m at the age of 60, assuming a return on investment of 10% per annum. If however they were to start at the age of 55, in order to reach the same target, they will have to save about Rs53,550 per month, nearly 5 times more.
Disclaimer: Investments in funds or directly into stock markets are risky and past performance does not guarantee future results. Gulf News does not accept any liability for the results of any action taken on the basis of the above information.
Cultural differencesa major factor
There are definitely cultural dynamics involved in how retirement is viewed. For Americans, there's not much reliance on children during retirement. In India, in the past there's probably been more of a dependence on the family in retirement. But as Truong says, dynamics are changing gradually. "In an increasingly globalised world where people are travelling and working and are far from their families, your children may not be there to physically take care of you in retirement.
"You may need to recognise that time have changed. You may need to be a little more selfish and prioritise your own retirement."
Budget separatelyfor health needs
Health insurance should be an important consideration for those returning to countries where medical care is provided essentially through a private system.
Americans, who have been overseas for a long time and are not eligible for Medicare or Social Security, need to plan for the costs of medical care and medical insurance, says Truong.
"You should plan to have an additional lumpsum set aside for medical care only."
In the case of India, Krishnan Ramachandran, chief executive of Barjeel Geojit Securities, says medical cover is an absolute must for every person about to retire. With the growing costs of medical care in India, an instance requiring hospitalisation can easily be a huge drain.
"A long-term investment planning must therefore allocate a portion of their savings, at the least 10 per cent, to take care of the medical premiums and also to meet any emergency costs," he says. For a British expat returning to the UK it may be less of a consideration. They can access health care through the NHS system, although they may prefer private insurance options.
