Accumulating wealth through superior investment returns is usually an investor’s primary focus during their working life. As a result, investment portfolios become skewed towards growth assets, such as equities, with little regard to the risks associated with generating higher returns.
However, as investors move from accumulating to preserving wealth, their investment needs and risk profiles change. Chasing higher returns decreases in importance. Instead receiving income and preserving, and even growing, capital become critical.
But are retirement investment portfolios changing accordingly?
Retirees have different investment needs
Unlike investors accumulating wealth, retirees broadly need:
• regular income – to cover living expenses and to keep pace with inflation
• lower investment risk – to preserve capital and reduce the impact of market downturns
• capital growth – to ensure their savings can adequately sustain them over the long term.
As investors move permanently out of the workforce their focus shifts from building assets to drawing down on their capital.
Without a regular wage or salary, retirees are more reliant on deriving income from their investments to cover expenses and over the longer term, to adjust for the rising cost of living.
Compounding retirees’ need for income however, is often a desire to reduce investment risk to ensure their money lasts.
While volatility can play a positive role in a wealth accumulator’s portfolio, that is, they may benefit from purchasing growth assets when markets are weak, during retirement, retirees have limited time and capital available to tolerate, or take advantage of, adverse market movements.
Minimising the amount retirees draw down is one way to preserve capital.
However, if a retiree’s portfolio comprises only growth assets, selling
investments to generate income when markets are down means when
markets improve, the capital value is unlikely to recover. Repeating this
pattern when markets suffer negative shocks can irrevocably damage a
retiree’s savings. Being cautious rather than increasing risk by chasing
higher returns however, can improve a retiree’s ability to protect their
capital and make it last longer.
Thinking longer term during retirement can be overshadowed by the emphasis placed on meeting shorter-term living expenses. However, with inflation and market movements inevitable over the long term, achieving some capital growth
during retirement can provide a buffer to market changes while reducing the risk retirees may outlive their savings.
Rethinking investing in retirement
Retiree investment portfolios have traditionally favoured defensive assets, such as fixed income and cash. Although this strategy may deliver regular income and reduced volatility, low prevailing interest rates may not generate sufficient returns to adequately sustain retirees over the long term.
Some believe blending defensive and growth assets can smooth returns
and reduce investment risk. However, these portfolios generally cannot
absorb the occasional extreme shocks equities can experience. If a
portfolio suffers a loss, to recover, investors can take on more risk by
chasing higher returns, or increase their time in the market. Retirees
however, have limited time and capital available.
“With living costs rising and people living longer, there is a real social and financial risk that retirees employing only an asset allocation strategy may outlive their savings.”
Equity income strategy
An equity income strategy has the potential to reduce this risk and become an integral part of a balanced retirement investment portfolio.
Equity income funds aim to generate income by investing in shares in a risk-controlled way. Exposure to equities allows retirees to access the inherent income-producing abilities of companies coupled with their potential to deliver higher returns, and importantly for eligible investors, the benefit of franking credits. While strong emphasis on managing downside risk aims to reduce the risk of capital loss.
The Vertium Equity Income Fund is designed to address the needs and satisfy the risk appetite of retirees by providing an attractive mix of income, reduced volatility and capital growth.