Heading into retirement and contemplating ending paid work, means you need to rethink the risks in your portfolio
Your new career – Director of Income
Are you fearful of retirement? The term ‘Retirement’ is a misnomer in so many ways. Most of us are very anxious for what retirement means for our lives. The allure of time to spend with your family and freedom from the demanding schedule of work is matched with a new set of responsibilities – that of financial survival as a ‘sole business owner’ to your household. Retirement is a change of career, not an end of a career.
The wealthy call it “running the Family Office”, but even that understates the number one responsibility of this new career - producing enough income from your assets to meet your family’s cashflow commitments and ensuring it lasts for the rest of your life.
We’ve called your new role Director of Income, or DOI for short. DOIs are basically CEOs of a very specific type. A DOI is responsible for making sure they can source a portfolio of income producing investments to fund their commitments.
The importance of this profession cannot be overstated. In fact, the consequences of not excelling at this career are arguably the most impactful of any career you’ve had before. Unlike an employment environment, you are very much on your own because its so personal and to most, our financial affairs are confidential.
So, for those who say “retired”, we say “changed professions”!
Why Director of Income is the fastest growing profession in Australia
We all know Australians are living longer. But when you take a look at the impact this is having on the ratio of the years we work versus the years we are “retired”, the pace of change is quite extraordinary. In a single generation our life expectancies have increased by 14 years.
As shown in Figure 1, only 40 years ago Australian’s worked nearly five times longer than they were in retirement – 42 years in the workplace followed by nine years of retirement. Now it’s only one and a half times longer – around 35 years working and 24 years retired.
Figure 1
Today the real challenge is that our average life expectancy has been pushed out to age 85. And, being the average, this means many of us will live well into our 90s. Our capital and income streams needs to last over 30 years – almost as long as the term of our working careers.
To many these extra years are a good thing, but as DOI, you now have a major responsibility on your hands.
Managing your retirement is no different to managing a business – the golden rule is make sure you earn sustainable cash flows: don’t risk your capital and don’t run out of money.
Assuming you are already retired, you need to earn more income without blowing up the business (your capital), and try to cut costs without killing off the business (your lifestyle)!
Ensuring your capital and incomes are sustained for 30 years, in order to provide financial security, is a considerable challenge for any business owner.
You are responsible for bearing the risk and consequences on your employees and shareholders (your family members).
As they say, the buck stops here. And unlike many businesses, this business simply cannot afford to fail.
The three stage transitional shift in asset allocation through retirement
DOIs are addressing the need for long term secure income streams through greater asset allocation to the fixed income/bond investment sector and in the process, reducing the risk and volatility to their capital.
During our careers we take on many risks. We have to do so for two reasons:
- Because we do not have enough assets yet to be financially independent so we have to take risks to create a greater wealth base.
- If we make poor investment decisions and lose money we can always repair our losses with next year’s salary or free cashflow – and cover up our mistakes.
With retirement option 2 is lost.
A significant shift in investment risk appetite or asset allocation should begin approximately 10 years before retirement as, this is when you hit ‘peak wealth’ and you need to start taking some risk off the table and focus on protecting your accumulated financial assets.
Retirement is the pinnacle, but what happens before and for a few years afterwards, can very much affect the type of retirement you enjoy.
We would suggest preservation of capital becomes even more important once retired and a strategy to do so is to allocate more of your portfolio to fixed income investments. Including term deposits, bonds and perhaps some older style hybrids.
As you can see from Figure 2 below, during your working career most investors allocate more capital to growth assets.
Figure 2
As you transition into retirement you need to protect your wealth by allocating more to fixed income and bonds, and in your last trimester you need to increase the security further.
Why Directors of Income are looking to the global pension funds for their SMSF insights
Back in the 1980s employers recognised the evolving longevity risk and its burdening financial consequences of funding defined benefits pension schemes for their staff. They could no longer absorb the expanding cost liability these extra years of life meant for pension payments and chose to transfer the responsibility of superannuation back to the individual. And so the SMSF path was laid.
Today when you look at the global pension fund asset allocations you see they invest over 50% of their assets to bonds and cash in order to both meet their liabilities and pay the income streams to their members for the durations of their lives and with the certainty the assets will last the distance. These funds adopt the ‘stage 2’ approach to asset allocation, balancing the diverse age groups stages of all their members.
This is a strategy that SMSFs are beginning to adopt where the direct bond market now is the fastest growing sector for SMSFs. SMSFs want access to direct assets – direct shares, direct property and now direct bonds and FIIG make direct bond access available from $10,000 per bond with a minimum $50,000 up front.
DOI is going to be the fastest growing profession in Australia over the next 20 years. Regardless, like in business, those that have a plan will succeed and those that don’t will not. Being a DOI is no different to being a CEO in that regard.
The key conclusion for the Director of Income is that it’s a lot more enjoyable in retirement with money than without it. So, make sure you reassess your asset allocation and ask yourself “Do I have enough defensive assets to protect me?”