Four retirement planning mistakes and how to avoid them

Successfully preparing for retirement can present many challenges. Here are four common mistakes to avoid when selecting your retirement investment strategy.

Mistake #1 – Keeping your accumulation fund

Accumulation funds are not suitable for retirees, because their main objective is to deliver a strong total return outcome – not a lower risk profile. So, it’s no surprise that when you measure the risk characteristics of many accumulation funds, they mirror or exceed the risk profile of the market.

By comparison, decumulation funds are lower risk and therefore better suited to retirees’ needs. This is because the overarching goal for retirees is to ensure their nest egg lasts the full duration of their retirement.

To decumulate with equities effectively involves applying three strategies – not independently, but concurrently.

  • Income first, retirees should aim for high levels of income from companies considered to be high quality and able to sustain their dividend payouts. This will help minimise the need to draw down on those investments.
  • Capital second, capital preservation is extremely important. It’s about minimising that sequencing risk during the critical 25 years around your retirement date, also known as the retirement risk zone. This is when retirees’ nest eggs are peaking and are at the greatest risk of significant loss from any market corrections.
  • Growth third, the potential for growth in capital can help reduce the risk of inflation eroding the value of the nest egg for the duration of the retirement phase.

Over the past decade, dividend growth or equity income has become a popular strategy among investors and retirees who are using it to deliver better outcomes for their retirement life. A dividend growth strategy is designed to deliver on all three needs above it has the equity exposure to generate dividend income while providing a hedge against inflation.

Mistake #2 – Falling into yield traps

When compared with the rates available on term deposits and bonds, the higher dividend yields can appear attractive. However, just like equities, dividends are not risk-free.

Whenever the market experiences some sort of crisis, earnings tend to fall and so do dividend yields. Added to this, there’s the risk of capital loss when stock prices collapse, creating a yield trap for investors and retirees. A good example of this is Telstra in recent years: it went from an expensive defensive stock to a yield trap as its yield payout climbed and its earnings fell.

Periods like the COVID-19 pandemic have shown that at certain times dividends can be just as risky as stocks. Share values typically collapse during periods when global growth slows as earnings are revised down. It is no surprise that yield traps can often appear when company earnings are unable to support dividend payments during those chaotic periods.

The deepest dividend cuts of around 50% occurred during the 1990s recession and the Global Financial Crisis in 2008. However, at that time interest rates were relatively high and offered an appealing alternative to the yield on equities. Today, with a greater asset allocation to equities in search of income, the impact on retirees’ portfolios may be larger.

Mistake #3 – Neglecting option income

Consistent income from equities may at times prove to be elusive if investors and retirees solely focus on dividends and franking credits. Instead, there is another aspect of equity markets to consider that can boost the capacity to generate income – option derivatives. And while dividends are often cut during a crisis, selling options can provide both a sustainable and reliable way to derive further income from equities.

Market corrections often occur when company earnings are expected to come under pressure, which can lead to dividend cuts. However, during market corrections market volatility typically rises, and this can lead to option prices increasing substantially. So, when dividends are slashed, increased income from selling options can provide a timely boost to portfolio income returns.

The combination of dividends, franking credits and option income can substantially improve the yield universe in equities. This means investors and retirees don’t have to chase just dividends for income and can avoid yield traps. Additionally, it limits the need for any large exposure to high income sectors if they are expensive, making your investment portfolio more diversified.

Mistake #4 – Using hope as a retirement investment strategy

One of the biggest mistakes to avoid is simply leaving your retirement outcome to luck or chance. Hope is not a viable retirement strategy.

Instead, retirees should be aware that they all have unique objectives that need to be met to achieve a comfortable retirement. Being exposed to reasonable returns over the long term will help mitigate any inflation risk that they may face during their retirement.

Retirees should also be exposed to lower-risk investments as this will help mitigate any sequencing risk if market corrections occur when their nest egg is at its peak balance as they approach or enter retirement. Additionally, higher levels of income will help mitigate drawing down too much from their valuable savings pool.

How the Switzer Dividend Growth Fund can help

The Switzer Dividend Growth Fund (Quoted Managed Fund) (SWTZ) is an income-focused exchange-traded managed fund (ETF) with a mix of yield and quality companies. The investment strategy is designed to deliver Australians a better investment outcome in the lead-up and during their retirement.

SWTZ is suitable for investors looking for lower risk equity market exposure or those drawing down on their savings. As an ASX-listed ETF, the fund invests in quality Australian companies with attractive valuations that pay consistent and sustainable distributions with the aim of delivering more income with less risk than the Australian share market.

DISCLAIMER: AGP Investment Management Limited (AGP IM) (ABN 26 123 611 978, AFSL 312247) is a wholly owned subsidiary of Associate Global Partners Limited (AGP) (ABN 56 080 277 998), a financial institution listed on the ASX (APL). AGP IM is the Responsible Entity and Vertium Asset Management Pty Ltd is the investment manager of Switzer Dividend Growth Fund (Quoted Managed Fund) (ARSN 614 066 849) (the Fund).

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