Learning to get along with risk
June 2016Many investors do not generate sufficient returns to fund their retirement and keep ahead of inflation. So what can you do to get more comfortable with risk?
Traditionally retirement has been viewed as a time to be conservative with your investments. The average Australian expected to save for their nest egg while they were working and rely on that money to fund their retirement. Times have changed. A slower global economy, low interest rates and the longer life expectancies require a different approach to retirement investing.
Your savings need to keep growing even after you have retired
Research shows that less than half of Australian super investors are willing to take on even moderate levels of investment risk. And this means many investors may not generate sufficient returns to fund their retirement and keep ahead of inflation. The reality is that, going forward, we are unlikely to see continuous periods of double digit growth. What does this mean in practice? For most Australians it means getting more comfortable with risk. And we know one of the best ways to get comfortable with risk is to understand more about it.
It’s the nature of investments that they will move up and down in value. And over the long term every investor should expect to experience both losses and gains. The issue for pre-retirees and retirees is that experiencing poor investment returns around retirement, when your nest egg is largest, has an outsized effect on your savings. A big loss just before retirement, or making withdrawals at the bottom of the market, can have a significant impact on your savings. Why? One reason is that your portfolio may not have enough time to recover even if the market does eventually rebound. And once you’ve retired, you generally have less money available to invest and ‘make up your losses’ because you are drawing down on your savings. This issue of timing is known as sequencing risk. So what can you do?
Returns that are less volatile have smaller ‘dips’ that in turn reduce the impact of sequencing risk. However while it can be tempting during times of volatility to switch investments to something ‘safer’ such as fixed income or cash, this may mean you are increasing the biggest risk of all – the risk of running out of money. Investing in lower risk equities (with higher income profiles) can enable you to reduce the potential impact of volatility and negative markets while generating returns that should continue to grow your retirement balance over the long term.
Making informed decisions
While it’s impossible to time markets, taking a mindful approach to your investments gives you more opportunity to manage sequencing risk. For example, if you do experience a large loss while you’re still working you may want to consider delaying your retirement date to give your portfolio more time to recover. By regularly reviewing your portfolio and seeking expert advice you can give yourself peace of mind that you are making sensible decisions about your investments.
Focusing on investors not investments
There are a number of factors that make saving for retirement more complicated these days. Retirement investing requires a focus on the investor rather than investments. For investment managers, this means taking the focus away from performance measures that rely on outperforming in rising markets and focusing on delivering inflation-plus returns and capital stability over the medium to long term.