Published in BENCHMARK SEP/OCT 2013 Vol.11 No.6
By Nicky Burridge
The run-up to retirement is a crucial period of retirement planning as investors look to transform their holdings from a growth portfolio into an income generation one. So what moves should you make in the 10 to 15 years before you stop working?
The main task in the years close to retirement is repositioning your portfolio away from growth assets into ones that will generate an income. Peter Kende, Chairman of Financial Partners, says “Depending on your age, your core portfolio will go from being around 80% of a balanced or growth portfolio to just 60%, 50% or even 40% as you near retirement.”
He suggests that people have an investment horizon of at least three years for a balanced portfolio and five years for a growth one, to ride out volatility. As a result, he advises people to only keep assets in a growth or balanced portfolio if they are confident they will not need to liquidate them during this timeframe.
Money that is taken out of a growth or balanced portfolio should be used to buy assets that will provide an income stream. Kende recommends people set aside a cash fund equivalent to six months’ income, then take out a series of fixed income products or bonds with maturities of 12 months, 18 months and two years. He says, “You should structure your portfolio so that you have maturities coming in every six months over a three year period.”
If you feel happy locking up your money for longer than three years, he suggests looking at higher yielding fixed income products, such as high-yield bonds, corporate grade investment funds or treasury inflation protected securities (Tips) to help prevent your income from being eroded by inflation.
Mark Kirkham, Chief Executive of Platinum Financial Services, says people should also reassess their appetite for risk and volatility in the run up to retirement. This investment period is about capital preservation, and people should position themselves to sell higher risk assets, such as equities, at the best time. He says, “If
it is a bull market, you may want to ride it for longer, could all be gone.”
Now is also a time to review your retirement plan to make sure you are on track to achieve the income you want, and to increase the amount you set aside if you are not.
What to avoid
One of the key reasons behind repositioning your portfolio is to minimize risk in order to preserve the capital you have accumulated. As a result, the final years in the run up to retirement are not the time to be considering high-risk investments, however good the returns appear to be. James Bolus, Chief Executive of International Financial Services, says, “Entering into new risky or volatile investments is a no-no.
Taking out gearing or new leverage against assets is also probably something to avoid.” He adds that people should also be cautious about investing in an asset that has a longer time horizon than their retirement date, particularly if it is a capital appreciation asset, rather than an income production one.
Currency management is also important at this stage, if your investments are not in the currency of the country in which you plan to retire.
Getting the right mix
While you will generally want to shift into lower risk assets in the run up to retirement, in the current low interest rate environment, you are unlikely to want to have all of your portfolio invested in cash and bonds. Bolus says, “You will need other asset classes in there to balance out the returns on cash and bonds. There are various grades of fixed income you can use to boost returns, as well as incorporate other asset classes, such as high-end dividend stocks and higher yield bonds.”
But he cautions that it was important to manage risk, and more volatile assets should make up only a small proportion of your portfolio at this stage. “There is no substitute for planning in advance to make sure that you don’t have to generate an unrealistic yield in retirement to live off,” he says.
Inflation is a crucial aspect of planning in the final decade before retirement. As a result, Kende recommends that people keep at least some of their investments in equities in order to produce returns that outstrip inflation. He says, “A balanced portfolio is likely to be 40% to 50% in equities.” But he advises people to focus on blue-chip stocks in major markets. “If you are going to put money into emerging markets you have got to be able to lose it,” he says.
Other financial demands
While investors may hope that they will be able to spend all of their surplus income boosting their pension during their final years of working, in reality, they are likely to face competing demands on their finances.
Kende says the best way to manage these conflicts is to identify potentially big expenses, such as sending a child to college and planning for them alongside retirement saving. If you have not done this, Kirkham urges people not to be tempted to cash in their retirement accounts to foot the bill, but rather to try to fund it from another source, such as surplus income. He says, “Alternatively, you could leverage existing assets, such as borrowing money against a property.”
Another approach would be to get your child to take out a student loan to pay the college fees upfront. “Then when you retire, take a tax-free lump sum from your pension and reinvest it,” Kirkham says. He adds that people could use the return on the investment to pay interest and some of the capital on the student loan, without having to erode their principal capital.
The financial consequences of an unplanned event, such as getting divorced, can be huge in the run up to retirement. While there is never a good time to lose up to half of your assets, when you are within 10 to 15 years of giving up work, you have much less time in which to make up the lost ground.
Kende advises people who find themselves in this situation to try to keep relations with their spouse amicable to avoid having to liquidate all of their investments for division, as this may mean selling some assets at a loss. He says people in this situation may want to delay their retirement to enable them to save more into a pension, but he cautioned against taking out higher risk investments in a bid to make higher returns. Bolus says, “Realistically you need to make adjustments to your plan. You need to prolong the expected time of retirement or put more in, if that is an option.”
While the final years before retirement are a crucial period in pension planning, it is important that this is not done in isolation. Kirkham advises people to check if other aspects of their finances are in order, such as having an up-to-date will and sufficient life insurance to cover any financial liabilities, if anything happens to them. Bolus adds, “It is important to consult a professional at this stage. Now would be the time to go to an adviser to make sure everything is on track and to create a blueprint to make any adjustments that are going to be necessary.”BM