Investing in Retirement

There is a solution to the problem of investing in retirement, the same solution people should always have adopted regardless of interest rates or valuations of other investments classes: the solution is to spread your money across all investment types and to get money into a range of different industries and countries. This is a diversified portfolio.

A diversified portfolio may not make you rich, but it is the best store of wealth ever invented. You may have built your wealth by concentrating your money to just one asset or asset class (you may have owned a business or some rental properties, or you may have invested aggressively in shares), but retirement is a time to lower risk as you start to enjoy what you have. Lowering risk means diversification.

There are plenty of options for diversification but that does not make it easy to choose which one. At the time of writing, there is only one fund which is a specialist drawdown fund, a fund designed specifically for retirees to invest in and draw out their money for a regular fortnightly income. (Disclosure: I am a director and shareholder of this fund.)

Other funds can be used to hold investment capital, which is then drawn on to provide a living. Many KiwiSaver funds are suitable for this, and other managed funds are also on offer from banks and fund managers.

A lot of people in New Zealand find it hard to get good advice. There are some very good financial advisers in practice but most only take on clients who have significant amounts of money (often the minimum is $250,000, but sometimes significantly more).

But people with smaller amounts either need to go to a bank or fund manager and take advice from people who are advising on and selling only their own product. Regrettably, many people are simply left to their own devices.

All of this is complicated by the demise of the Defined Benefit superannuation scheme. These schemes, which started to be wound down in the 1990s, paid a percentage of finishing salary. Typically, employees would pay into these schemes and when they finished their careers as doctors, managers, teachers, etc., they would receive 60% of their salary until they died. These schemes were marvels of generosity — the contributions employees made went nowhere near covering the cost and left the government (in the case of public service employees) and companies (in the case of private-sector employees) holding big liabilities.

Such was the cost, these Defined Benefit schemes were closed to new members. There are still plenty of people receiving them, but none is open to new members — the cost of paying a lifetime pension means no Defined Benefit scheme is ever likely to emerge again.

Now we are left to our own devices. Superannuation savings and KiwiSaver now have Defined Contribution (that is, we know the amount we are contributing but not what will come out in the end). At the end of employment, we receive a lump sum according to what we have contributed, the amount our employers may have contributed, and the investment returns we got on the way through.

It is then our job to convert that lump sum into a pension. This job had been both so difficult and so expensive for Super schemes (with their investment experts and actuaries) they stopped doing it. Now we expect everyone to be able to do it themselves, without access to those actuaries and experts. That is a very big ask.

Drawdown — how much can you take?

Given we all have to look after our own money and investments now there is no joining a Defined Benefit scheme, there are and will be problems. These problems of how to invest in retirement are in addition to that age-old problem of knowing how much you can reasonably draw from a portfolio. Even when retirees have invested their money well, they face the problem of figuring out how much they can take from the portfolio on a monthly or fortnightly basis so the money will last as long as they do.

This is setting the right drawdown rate and it is critical to a good retirement. If you take too much from your portfolio, you run up against longevity risk; your money may not last as long as you do and you end up in your final years reusing tea bags and rationing the wine biscuits you eat for dinner. On the other hand, if you take too little, you forgo lifestyle — the children will benefit, at your expense, from your lower expenditure as you leave bigger inheritances.

There are two things most people will have to do for a decent retirement:

1. You will have to invest in a diversified portfolio which, as will become clear, is no bad thing. No longer can people live on the interest from bank deposits and the likes, instead you will need to invest in a managed fund (or funds) and possibly enlist the help of a financial adviser.

2. You will need to spend not just the returns you get from investments but also some of the capital. This means, in retirement, you will probably need to decumulate your savings, leading to smaller inheritances for the children.

These should be the best years of your life, but you need a happy fit between you and your money. Whether you have millions, or something more modest, you will have decisions to make.

This edited extract is from Cracking Open the Nest Egg by personal finance expert Martin Hawes. The book sets out to help people with the way they should invest when the nest egg has hatched, and how they draw down from their savings to give a good retirement. The book is available now where all good books are sold ($39.99 RRP, Upstart Press).