The dilemma of maintaining lifestyle or preserving savings
ADRAWDOWN rate of six percent is common in retirement investments but Marriott’s research shows that
at that rate, almost half of retirees would have run out of capital within 30 years, according to investment professional Lourens Coetzee.
He adds, “The concern for retired investors today is that market returns are expected to be below average for the next decade.
“This is due to demanding valuations combined with lower growth expectations and suggests many living annuities will come under pressure in the years ahead.
“If you spend more than you earn, you will erode your capital and ultimately erode your income.
“When it comes to investing, particularly in retirement when capital preservation is paramount, this ageold wisdom rings true even today.”.
Marriott, he explains, specialises in income focused investing and has researched the sustainable levels of income that retirees were able to draw historically, to better understand the difficulties retirees face and why in retirement you should spend the income and not the capital.
Coetzee acknowledges that retirement can be a daunting prospect. “Retired investors commonly face the dilemma of either maintaining a certain lifestyle or adjusting it in order to preserve their savings.
“Typically the more income one draws and spends today, the less is available to create future income.
“When inflation is added to this quandary, it becomes important to also grow that income over time to retain one’s buying power.”
Historic analysis
Marriott’s research, using returns for South African asset classes going back to 1900, tested how much retirees could safely draw from their savings without running out of capital for three decades.
The assumption was that each retiree had invested R1million in a typical balanced fund which comprised of 60 percent equities, 30 percent bonds and 10 percent cash. It drew an annual income that kept up with inflation.
The graph below shows the maximum initial safe withdrawal rates retirees were able to draw and not run out of capital over a 30 year period. SEE GRAPHIC ABOVE: Source: Calculations: Marriott, Data: I-Net and Professor C. Firer’s studies on the history of capital markets. Initial safe withdrawal rates have fluctuated significantly over time. Some retirees were able to start with a withdrawal rate as high as 13 percent, grow their income in line with inflation and still have a successful retirement (capital lasted for 30 years).
A closer look at the data revealed that maximum safe withdrawal rates correlated with the first 10 year annual real returns the investor experienced.
In other words lower maximum safe withdrawal rates coincided with lower real returns and visa-versa. This seems obvious but the difficulty retirees face is that future returns are very difficult to predict.
The table below summarises the percentage of retires who failed using different drawdown rates for all 88 retirees with a 30 year investment horizon. SEE TABLE ABOVE: Source: Calculations: Marriott, Data: I-Net and Professor C. Firer’s studies on the history of capital markets Marriott has two suggestions:
Match income drawn with income produced
Investors should be aware of how much income their portfolio is generating and try to draw no more than the income produced – thus avoiding capital erosion.
It is especially important in the early stages of retirement that capital is preserved as far as possible.
Choose investments which produce consistent income streams that grow over time
Investors need to preserve capital and ensure they protect themselves against the impact of rising living costs over time.
Investments that produce a reliable income stream that grow over time, like equities, are critical as the income produced tends to grow ahead of inflation.
“We suggest that investors examine their situation carefully when considering using capital to supplement their income and strongly urge them to preserve capital until they reach a stage in their retirement years when it may become safer to drawdown.
“They may find it challenging to restrict their annuity income to the income produced in the current low yielding environment, but it is preferable to finding that one’s capital has been partially or even completely eroded.
“Rather be conservative now than risk having to find another source of income in the future.” he concludes.