HOW TO INVEST WHEN YOU’VE RETIRED

How to Invest When You’ve Retired

Some advice from a friend

Retirement is a dangerous time. Much of your income is completely out of your control, determined by the state (your statutory pension), or by the contractual terms of your private pension. If things go very wrong because of huge unexpected expense such as medical, family crisis (you need to support a son or daughter), or a financial disaster, you’re very unlikely to be able to rebuild lost capital.

You have to plan your situation carefully when you retire, maximizing income, minimizing risk to capital, and doing as much as you can to prepare for survival of “black swan” events.

Much of your income will be pensions. The balance will need to come from investments. If you use capital to buy an annuity, that guarantees a stream of income until death, eliminating the risk of outliving your savings. But annuities, whose value is geared to interest rates on bonds at the time they’re bought, have become extremely expensive because of ultra-low, even negative, interest rates. You should look elsewhere for the additional income you’ll need.

How much of your savings will you be able to withdraw without running out of money?

You’ll need to estimate how many years you can expect to live based on your health and family history. American government tables suggest that the average life expectancy for a male of 60 in the US is 21 years. If 65, 17 years; for age 70, 13 years; for age 75, ten years; for age 80, eight years. The average is two to three years longer for a female.

There are several reasons why you are likely to live longer than these averages suggest. One is that medical advances are keeping people alive for longer. Another is that the mere fact that you’re reading this infers that you’re better educated – therefore you’re more likely to practise a healthy lifestyle and have access to above-average medical care.

You may worry that the pandemic increases the risk of your dying early but that fear is quite out of proportion to reality. Unless you have comorbidities such as heart disease, strokes, diabetes, obesity, the danger from Covid-19 is no greater than from flu. 

You’ll probably live for longer than you expect, so err on the side of caution in 

drawing on your savings and plan accordingly. If you have a partner it’s important to take her/his life expectancy into account in your planning as well as your own.

How much income will you need?

You may be able to trim your spending from current levels because you’ll need less for expensive luxuries such as foreign travel that you spent pre-pandemic. That becomes increasingly onerous and less pleasant as you age. On the other hand you’ll almost certainly need more help in the home and more medical care – your need to finance the latter will depend on your access to services and drugs paid for by the state or by medical insurance. You may wish to plan for help for family members, such as grandchildren’s university education.

In addition to income you need to plan to have some capital to meet unexpected major expenses.

Received wisdom used to be that retirees should favour bonds for security and a fixed income. Trouble is, for years central banks have been pursuing extremely aggressive policies that suppress the yields on bonds and make them very poor sources of fixed income. The same extraordinary policies keep bond prices very high and therefore very exposed to inflation risk.

Bonds, properties and equities

As bonds and bank deposits have become very poor investments they shouldn’t be used except to hold a couple of years of income.

Property rentals are a useful alternative source of income for retirees, but real estate requires active management (the older you get, the more difficult that is), and has well-known downsides of lumpiness (just one property is likely to be a big chunk of your capital), risk of voids (periods without occupying tenants); and illiquidity (cannot readily be converted into cash).

Most of the capital you have to finance your retirement will need to be invested in equities. It now makes sense to maximize holdings of retirement capital in equities – 80 per cent or more of a portfolio – to yield adequate income, shield your capital against inflation risk, and provide a pool to draw on for emergencies. 

For most of us, the best source of additional income will be dividends. Once you stop working you may have to allocate a major share of your investment capital to “equity income” – shares held primarily for their income rather than capital gain. (Although, ironically, they sometimes turn out to be excellent long-term performers).

There are some very good specialist international funds, or if you prefer, ones focused on single countries such as the US, or regions such as Europe or Asia. An example of one I hold myself is the Henderson Far East Income fund yielding 7.7 per cent a year in sterling, payable quarterly.

Some advisers say that rather than resort to equity income stocks it makes more sense to focus on high-growth companies, selling small portions of a holding to yield capital as an alternative to income.

Diversification to reduce risk always makes sense in terms of different regions and investment styles as well as asset classes. This means you’ll be less likely to end up fixated on income-producing investments – a mistake in retirement planning that’s easy to make.

Of course income isn’t the only source of your personal wealth. Hopefully there are also capital gains. And presumably you know those from your regular monitoring of your investment performance. If you have accumulated enough capital, and if you’re a fair hand at investing, capital gains should be enough to cover any gap between income and spending.

How many more years must you need to finance?

Predicting what gains are likely to be is notoriously difficult. Yet doing so is important if you’ll have 15 or 20 years or maybe more to provide for yourself. And for your partner, if you have one, who is probably younger than you and therefore likely to live for more years than you, and is almost certainly less experienced than you about investment.

Total return from my own portfolio has averaged 9.5 per cent a year in sterling terms since I retired 20 years ago, of which I used 2.5 percentage points to finance lifestyle, the balance being reinvested. That return was not boosted by big bets on speculative stocks or options. Indeed, over the period the portfolio held significant components of “defensive” investments such as government bonds, gold and income-focused equities.

Of course it’s true that I qualify as a professional (financial journalist, not investment manager); often pursue very unconventional strategies that occasionally turned out to be big winners; and have had more than my fair share of good luck.

Given the generally mediocre outlook for global investments (valuations look far too high), I assume I won’t do as well over my remaining years. Perhaps averaging no more than 5 per cent a year, a bit less in real terms. That would probably be a sensible target for you to seek to achieve.

In planning your future the good news is that, providing you don’t have to, or wish to, leave an inheritance beyond that needed to support surviving partners or other family members, you can consume capital to maintain your lifestyle. On the other hand you do need to worry about living “too long,” or significantly longer than you expect to.

I suggest that you base your maximum annual withdrawal plan on the conservative assumption that you will live to reach 100. If you’re now 65, for example, you would plan to draw and spend no more than one 35th of available capital.

A final point about this kind of retirement planning is that it assumes you can’t change the cost of your lifestyle. Although that’s very difficult at an advanced age, it can be done. We relocated to Thailand when I had reached the age of 70. It halved our essential living costs. Or, to be more accurate, we got and continue to enjoy much more quality at much less expense.

End

9 Sep 2021