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Retirement Planning
Tuesday, April 1, 2008
Spend the income not the capital

When gearing up to retire, investors should look at making a seamless transition from pre-retirement to post-retirement, as far as their investments are concerned.

Sarika Modi, Head of Product Development and Strategy at Marriott, explains, “Investors often move their assets into cash at some point in the five years leading up to retirement, but this does not always serve them well. An attractive alternative would be to start aligning their asset allocation in their pre-retirement years with the desired allocation for post retirement and thereby create a smooth transition into retirement.”
When retiring, being able to draw an income from your investments becomes important. By creating the ideal income-producing portfolio in the run-up to retirement, the retired investor will be able to seamlessly start drawing down on that income in the retirement years.
It has been fashionable for investors to shift all assets into cash late in their working lives in order to reduce capital risk. However, this introduces different risks. Apart from the opportunity costs involved with being out of the market, there are also additional trading costs, uncertainty of price levels that one would need to pay in order to get back into the market and critically uncertainty of the amount of income the portfolio would be able to generate at the retirement, there by preventing a retiree to plan for income appropriately.
By establishing a desired, strategic asset allocation and then giving asset managers a flexible mandate, to enable them to manage the tactical asset allocation, investors will be in a position to reduce those risks. Asset managers need the freedom to make the hard decisions, particularly in turbulent times.
“One of the greatest problems is that retirement takes place on a specific date,” comments Modi, “and investors have been told that they require a certain amount of capital on that date in order to maintain their standard of living.” This can often result in a disruption to their portfolio as that becomes a fixed target. It would be better to view retirement as simply part of a progression and not as an end in itself. By adopting an income focused approach to investing, the investor is able to know well in advance the amount of income produced by the portfolio and manage the portfolio with this income objective in mind.
Heather Mostert, Head of Marketing at Marriott adds, “We believe that, in retirement, investors should ‘spend the income, not the capital’ and this becomes increasingly important in volatile markets as the dangers of eroding the capital base by drawing an income not supported by underlying earnings in a declining market become a very real concern. If investors don’t have the income, they don’t have it and they really shouldn’t be drawing down capital to fund their lifestyle. The risk of doing this is that the capital could run out.”
SA Reserve Bank Governor Tito Mboweni would agree. He has long been advising people to live within their means.
The change in regulations governing living annuities is to be welcomed. Previously, investors were compelled to draw between 5% and 20% of the fund value annually. This has been lowered to 2.5% to 17.5%, meaning that a greater proportion of the assets will remain in the fund, with a concomitant potential to drive capital growth.

Copyright © Insurance Times and Investments® Vol:21.3 1st April, 2008
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