Clients' retirement can be ruined by one bad year
New Zealand financial advisers need to talk to clients about how their retirement income would fare if there was a significant downturn soon after they stop working, it has been suggested.
Tuesday, March 14th 2017, 6:00AM 1 Comment
by Susan Edmunds
Financial advice consultant Grant Pearson, of Longitude68, said sequencing risk – relatively poor returns in the early years of a retirement – could ruin a person’s financial plan, even if they had saved enough money.
He said 2008 was a recent example where many well-prepared retirees had come unstuck.
“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.”
Pearson pointed to a case study of 10 couples, each with $1 million invested in the S%P500. They retired at a rate of one a year between 1977 and 1987. They all withdrew $100,000 a year plus an annual increase of 3%.
Three couples ran out of money before 30 years was up. Seven ended up with balances between $500,000 and $3.2 million.
The three who ran out retired in 1977, 1981 and 1986.
Pearson said the first five to 10 years of their investment returns were subpar. The couple that ended up with the most money in the bank had the best returns in the first five years of their retirement.
“Even though the rises over time will provide an average return outperforming other forms of investment, it is the retiree’s need of constant drawdowns without periods of sub-par results in the early years, which interferes with a happy and secure future.”
He said retirees could help avoid the problem by having two years’ of income in a cash account, investing in equity funds that aimed to produce a growing portion of income, diversify and downside protect.
He said it was possible another period of poor returns was just around the corner. “On average, every six years [there is] one big enough to destroy a retirement. It’s been five years since the last.”
He said advisers should talk to their clients about the potential problem and show them examples. “Provide a factual data table listing the downs in markets. How deep, when and for how long for each fall since 1900. Examine its impact on them – ‘what would life be like if your income was cut by a third or half?’
“Get them to verbalise what they imagine. Outline the measures you've taken to reduce its risk and its impact. All this reinforces the benefits of a good adviser. You are not remembered by how much you made them, rather how little you lost.”
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