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Navigating Retirement

As life expectancy increases, retirees face unique financial challenges that necessitate a careful approach to investing. Both pre-retirees and retirees often exhibit a risk-averse mindset, especially during market fluctuations, which exposes them to what is known as sequencing risk – the risk of market downturns affecting the timing of withdrawals from their investment portfolios.

One significant issue is the tendency for non-advised retirees to de-risk their portfolios after market downturns. This reaction can lead to holding cash or other defensive assets at precisely the wrong time, which can multiply the harmful effects of sequencing risk. For instance, retirees may withdraw funds from their portfolios when they are down, diminishing their ability to recover when markets rebound.

Understanding The Psychology
Richard Thaler coined the phrase ‘loss aversion’, in which individuals perceive an actual or potential loss as psychologically or emotionally more severe than an equivalent gain. In fact, studies indicate that retirees fear loss five times more than they value a gain, largely because they have more to lose and less time to recover. This emotional response can result in poor investment decisions, especially during market corrections.

Sequencing risk is at its greatest when people are nearing retirement. For example, a 30% market drop at age 65 could wipe out 13 years of retirement income, while a 30-year-old experiencing the same drop might lose only five years’ worth of income. Thus, the preparation for retirement occurs three to five years out at the latest.

Managing Behavioural Risk
Keeping clients invested in the market is one of the primary challenges, particularly during volatile times. Future Gen employs a multi-tiered approach that includes active management to minimize risks for retirees.

One effective strategy is the ‘bucketing’ approach, which divides assets into separate pools, each designated for different time horizons and income needs. For example, a long-term bucket allows retirees to maintain exposure to growth assets, while a short-term bucket provides immediate income. The medium-term bucket provides both income and growth without necessitating the liquidation of growth investments during downturns.

We maintain a growth bucket in our investment strategies to ensure our clients can continue to benefit from market upswings and mitigate the effects of inflation. By withdrawing from their short-term bucket during downturns, retirees can allow their medium and long-term buckets the opportunity to grow and buy depressed assets at bargain basement prices.

Systematic Risk Management
Associated with the work we do is a systematic risk management strategy. We understand the distribution of potential returns and are aware of the likelihood of various outcomes. For this reason, we expect the investment managers we select to be actively managing the asset classes for which they are responsible. If asset prices are too high, we expect they will take profits, and if they are low, we expect them to invest.

We watch these investment managers carefully and move the levers at a macro level to take on more or less exposure to growth depending on the circumstances.

Adapting To Change
Markets will rise and fall. However, the key concern for our clients is always maintaining their lifestyle and, more importantly, not having their lifestyle choices affected by volatile investment values.

For this to be achieved, we need clear and concise communication. Clients need to understand the rationale behind their investment strategies. This understanding, in turn, reinforces confidence in the long-term plan.

If this article has provoked any thoughts or concerns, please feel free to reach out to us.

Speak to one of our financial advisers