Investment commentary June 2017
How to help your money last through retirement
Your investment needs change throughout your life. While you’re working and saving for your retirement, you tend to focus on growth. Most people know about the magic of compounding and since you don’t need your money for a long time, you may not give much thought to the amount of income your savings are generating.
However when you’re at or reaching retirement age, you realise the next challenge is to convert your savings into an income to support your lifestyle in retirement. At that point, people often focus too much on income, and forget about growth and even diversification. This could be risky. Here are 3 important tips to remember.
1. Keep in mind what inflation can do to your savings
Assets which only provide income with no capital growth, like term deposits, tend to be more stable, but returns are also low. If you need your money to last a long time then you need to consider the impact that inflation will have on the cost of living.
Often investors who are concerned about generating income put together a portfolio of shares with high dividend yields. Dividends are generally quite stable, and if you have a large enough pool of savings you might be able to live off the income of a share portfolio and leave the capital alone.
But chances are, the income won’t be enough to fulfil your goals, and you’ll need to supplement it by selling down shares over time.
2. Don’t be too concentrated
Dividend and yield-focused investing has always been popular, but over the last few years it seems to have really taken off. Exchange traded funds (ETFs) are managed funds listed on the stock exchange. They are available for different asset classes and focuses, and tend to be a barometer of what types of investment strategies are popular with investors.
On the Australian stock exchange at the end of May, 11 out of 17 strategy ETFs are focused on dividends. Six years ago there was just one.
Focusing on shares which generate high levels of income may seem like a defensive approach, but it can actually be quite risky if the strategy leads to a portfolio that’s concentrated in a small number of sectors.
A recent example of where this vulnerability can be exposed is in the performance of the Australian banking sector in May. A combination of the bank levy announced in the Federal Budget, and ongoing nervousness about the potential for credit losses in the housing market, saw bank shares sell off 10.2% for the month.
Of course if the concerns about the housing market came to fruition and banks were forced to cut their dividends then we would likely see much steeper falls.
3. Focus on diversification, not just income
A better way of generating a sustainable income in retirement is to hold a well-diversified portfolio across a number of strategies and asset classes. You can supplement the interest and dividend income you’ll earn from this by taking a disciplined approach to selling down assets over time.
By focusing on diversification rather than income you can maintain enough exposure to growth assets to outrun inflation, but your portfolio won’t be as volatile as if it was only invested in shares. This reduces the risk that you end up in a position where you’re forced to sell assets cheaply to fund your lifestyle.
If you’re wondering how to go about generating an income from your investments you should speak to your financial planner, who can help you construct a sustainable retirement income strategy.