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The truth about managing retirement income

Sunday, August 7th 2011, 12:46PM 3 Comments

by Goldie

Too many advisers remain fixated on the outmoded income or growth bias when constructing portfolios. This is short-sighted and leaves the client losing out on returns they could achieve in many economic cycles, as well as living less comfortably than they could. There is only one optimal way to construct a portfolio – to maximise Total Returns (within a given risk profile). Then all one needs to do is manage drawings as an annuity, keeping the portfolio in line with future financial planning. The objective is to put the investor’s needs first. The individual’s cost-of-living does not change with the fluctuations of a portfolio’s ability to produce income, and nor should it. Those still trying to construct a portfolio looking for income investments to match clients' cost-of-living are doing their clients a disservice. They may also be subjecting the client to more taxes than is necessary. Part of this misguided mode of constructing portfolios comes from old trusts that were structured with ‘Income’ benefits to surviving partners and residual ‘Capital’ to other beneficiaries. We all know the court cases of this misguided approach when trustees focused excessively on the surviving partner not taking sufficient account of capital beneficiaries’ rights - and hence not growing capital to even modestly keep pace with inflation. ‘Income’ and ‘Capital’ beneficiaries’ interests must be, and can be balanced. Another reason for some advisers not pursuing total returns may be that they do not manage the cash component of their clients’ portfolios very well. Cash is an asset class. Beyond receiving interest, coupons, dividends and distribution, a cash component to a portfolio is essential to facilitate rebalancing and re-investing. People giving free advice in the mainstream media have recently bewailed a perceived ‘gap’ exists in New Zealand with few annuity funds available for people to utilise when they get to the age they can pull money out of their KiwiSaver scheme savings. A balanced fund is just such a scheme and can readily be utilised to meet cashing-up KiwiSaver’s required expenditure in retirement. Also consider, that annuities (and I am sure there will be a plethora of them in New Zealand shortly as the insurance companies look to make a buck) consist of an underlying pool akin to balanced fund, one from which the insurance company pays out the regular annuity and pockets the remaining portfolio for itself as the profit. Of course the annuity does spread the risk that an investor will outlive drawings from their own portfolio, by packaging their odds with another poor devil who dies early and misses out on both income and capital. But this can be countered by really good financial advice, calculating and fostering sufficient client savings (portfolio) to outlast their lifetime of drawings. Investors with a good level of savings will be more efficiently served to go for the self managed balance portfolio or fund approach. A warning - don't get glassy-eyed when the avaricious insurance companies come to town with their glossily packaged, ‘new’ annuity products. You can be sure their actuaries will have worked out a handsome profit. Doing what is best for clients may be managing the portfolio for Total Returns, keeping residual capital for the client’s estate. Added value for your clients is a fee well-earned.
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Comments from our readers

On 7 August 2011 at 9:45 pm Forthright said:
Don’t know who the author is but at least they got two things right; The objective is to put the investor’s needs first; Added value for your clients is a fee well-earned.

The balance of the article seems to push the authors prejudice to a number of other bonefide ways to meet clients’ objectives for a reliable retirement income. The author also seems to want to ignore the fact many investors seeking retirement income want to use less risky fixed interest investments, such as bank deposits, government or low risk listed bank, local authority or corporate bonds.

Let’s face facts here, which have done better over the last 10 years, the balanced managed fund or the less risky fixed interest portfolio of investments. Yea yea I know before you burst into print the last 10 years have seen events never seen before and blah blah blah the poor sod in the balanced managed fund will be better off over the long term. But the long term for a seventy or eighty year old may not be that long.

There is also the fact of a recent High Court opinion, that having less risky investments in a portfolio, for those requiring income is a good thing.

The author also tells us there is only one optimal way to construct a portfolio – to maximise total returns (within a given risk profile). This investment philosophy does nothing to reduce risk, rather it only serves to mitigate the impact of significant drops over an appropriate time period by saying you need to wait to maximise your total return. In other words you invested in this portfolio today, tomorrow the market has dropped 20% and now you may have to wait 10 years to recover and be ahead of where you were, when you started. Happy client, I think not.

Perhaps we need to alter our thinking and by all means put the client interests first, by meeting their investment objectives and maintaining a balance between producing income (if required), preserving capital (if required) and growing wealth (if required) that is appropriate to the investment category in which the clients portfolio is positioned as part of a diversified financial plan. I then have no problem charging the client a fee for the value added.
On 8 August 2011 at 3:23 pm Philip said:
Russell has some interesting views on this over here
On 11 August 2011 at 8:30 am Fred said:
'Forthright' says, "Let’s face facts here, which have done better over the last 10 years, the balanced managed fund or the less risky fixed interest portfolio of investments".

Beware survivor bias. Fixed Interest portfolios of 10 years ago invariably included Debentures, and often Property Syndicate Capital Notes, and sometimes Mortgage Funds - many of which are now gna or frozen. The poor souls holding them for living income are in penury.

Balanced funds have served their owners better than that.
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