After using your post-retirement expenses to generate a cash flow analysis and to determine your wealth allocation framework, you should consider the following risks.
It is crucial to diversify among asset classes, fund managers and markets. Investors who try to manage their own portfolios are frequently caught off guard by overly concentrated portfolios, hindsight bias, paralysis, or listening to too many people. Some investors have a random collection of investments that were good ideas at the time but lacks a master plan. They may be committing what US fund manager Peter Lynch referred to as “diworsification”. If used appropriately, however, diversification aids in downside protection by combining uncorrelated assets, using skilled managers, using funds with different investment styles, using more than one currency, and matching different return profiles.
Risk and return
Some investors trade lower long-term returns for lower risk. Others strive to strike a balance between the risk and return of a diversified portfolio. Others are willing to take substantial risks with a portion of their portfolio to increase their long-term return. You won’t get the historical track record if you buy the hottest or most popular fund or asset class today. Reversion to the mean, one of the market’s most destructive forces, is more likely to occur. Working with an adviser will assist you with your asset allocation and rebalancing when your portfolio becomes unbalanced, allowing you to avoid the classic mistake of buying high and selling low.
Costs and taxes
In a low-return environment, costs are under pressure. Looking at costs in isolation is unhealthy, but layers of costs become a barrier to achieving returns, and high costs do not equal high returns. Markets are beyond your control, but you can manage costs. Keep in mind that you can’t get something for nothing. You cannot expect a company to provide you with good advice and excellent service if you refuse to pay for it (as opposed to paying for products). When it comes to taxes, never underestimate the value of professional advice. If your marginal tax rate is high, you can make your portfolio more tax-efficient and cost-efficient by using endowment wrappers, maximising tax-free growth in retirement funds and tax-free savings accounts, managing lump sum withdrawals from retirement funds, and lowering platform costs and fund fees.
Challenges and intelligent choices
Investors should be aware that the future is uncertain, and their reactions to bear markets and market corrections can have a significant impact on long-term investment performance. Investors should avoid panic selling during market declines, because being out of the market for a few days or months can mean the difference between having an inflation-beating portfolio or not.
Many, if not most, retired investors lack the capital and assets necessary to finance a sustainable income that will allow them to maintain their previous standard of living. In South Africa, the average income withdrawal rate is 6% to 7%. More than 65% of those drawing more than 7% of their income will run out of money. Older annuitants with limited capital may benefit more from a guaranteed annuity because they require certainty in meeting essential monthly expenses. A qualified financial planner’s assistance is required to determine what is best for a client in the long run.
Underestimating one’s life expectancy is one of the most common mistakes investors make when planning for retirement. The age of 65 is no longer considered old. According to the World Health Organization, ages 18 to 65 are considered young, ages 66 to 79 are considered middle age, and ages 80 and more are considered senior or elderly. People are living longer lives while remaining active. Most retirees will slow down, work less, and enjoy some leisure time while continuing to engage in useful income-generating activities. Many things are now possible thanks to technological advancements. You don’t have to stop working because you’ve reached a certain age. To generate passive income, I advise clients to be more creative and re-invent skills: retirees have valuable life experience. There is always a way in a world full of options, whether it’s Airbnb, online tuition, or coaching.
Mark Twain said “It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just aint’ so.” Every day, people are bombarded with information, and many retail investors lack the resources and skills to critically evaluate that information. That is why many retail investors are late to the party and find it difficult to leave when the party is over. You must ignore the noise. Don’t blindly follow the crowd. With anonymity, there is no accountability.
Retirement planning is a multifaceted science that encompasses far more than investment strategy. A Morningstar Research report, ‘The Value of a Gamma-Efficient Portfolio,’ concluded that working with a financial adviser who provides both comprehensive advice and high-quality portfolio services is likely to benefit the average investor significantly. When you plan, keep to your plan, and make smart choices, you can increase your after-tax, fee-adjusted performance.
Created by Jeanne-Marie Lombard CFP®, FPSA®, TEP