GET A LIFE BEYOND RETIREMENT
MOST INVESTORS WILL be familiar with the term “life-stage investing”. It’s a seemingly logical and quite appealing investment concept, especially for investors approaching retirement. The basic idea is that as you get closer to your retirement date you gradually lower exposure to riskier investments (read equities) until, upon retirement, you’re invested in fixed-income assets, typically money market funds.
The concept seems fine and it’s popular with financial advisers. It removes risk from their shoulders – and seemingly from the investor – up to retirement. What happens after that is less clear, and Foord Asset Managers says life-stage investment portfolios can pose a significant threat to long-term wealth and income.
Life-stage investing might work well if individuals actually retire on the set date. Often they don’t. And the thing with retirement savings is it helps to know exactly when you’re going to die. Die too soon and you may have lived struggling to make your retirement savings last. Live too long and your retirement savings can run out.
However, a number of financial institutions use life-stage investment products as the building blocks in retirement funds. “The management boards of retirement funds that offer these portfolios – often as the most popular default fund – have typically concerned themselves with providing fund members with a low risk financial solution leading up to retirement,” says Foord MD Paul Cluer. “However, Foord believes they may have failed in their fiduciary responsibility to provide their members with adequate preretirement counselling or solutions sustainable on a post-retirement basis.”
Foord uses a real example from a major life office to illustrate the point (see graph). The Growth Portfolio targets CPI plus 5% through a traditional asset allocation fund, the Consolidation Portfolio CPI plus 3%, through an absolute return portfolio, and the Preservation Portfolio targets money market returns.
“At first glance this practice seems sound,” says Cluer. “But there’s a major flaw with the use of a life-stage model – it requires that you actually retire at your planned retirement date and not before or after. Plus it’s based on the assumption that you’ll use all – or the major part – of your retirement benefit to buy a guaranteed annuity from a life company.”
Cluer says if you invest in a life-stage portfolio and one or both those prerequisites don’t apply “you may be fundamentally endangering your ability to generate sufficient retirement savings to maintain your lifestyle post-retirement”.
If you retire early you’re exposed to both market risk and interest rate risk when you buy your annuity. “If you retire later than planned you’ll be invested in a cash portfolio for too long. And to the extent that you don’t buy an annuity you’re stuck in cash – or must recommence investing in riskier assets, potentially at market peaks.”
But beyond that Foord believes buying a guaranteed annuity at retirement “is poten- tially one of the worst investment decisions you can make. And if you eliminate guaranteed annuities, there’s no need for the damaging life-stage portfolios that have become so popular.”
Foord lists many potential problems with guaranteed annuities. Cluer says the basic guaranteed annuity will pay you a fixed pension for the rest of your life – but when you die the annuity ceases and nothing’s left in your estate.
What’s basically happening is the life office that issues the annuity is taking a bet. If you die early, the life company will benefit. If you live longer than their actuaries calculate, they don’t benefit (as much). But Cluer points out the effects of inflation on your fixed annuity will have ravaged your buying power and lifestyle. He says inflation-adjusted annuities exist but are expensive. More than 90% of the guaranteed annuity market comprises fixed annuities.
The above supports Foord’s contention that life-stage portfolios are designed for the sole purpose of feeding into fixed annuities.
But what are the alternatives? Cluer says first make sure you start contributing to a savings or retirement portfolio early in life. “Thereafter, plan to remain fully invested throughout retirement, harnessing the power of compounding for the duration of your life.”
His advice is to remain invested in a diversified portfolio with sufficient equity exposure to generate a real return over time. To confirm that, Foord tested life-stage portfolios and fixed annuities against traditional balanced funds, using historical market data. “The findings were overwhelmingly in favour of balanced portfolios,” Cluer says.
Its findings are in a two-page report Finweek has seen and it certainly looks like balanced funds are the best option, even after retirement.