Finweek English Edition - - Creating Wealth - SHAUN HAR­RIS shaun@fin­

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.

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