When it comes to planning for retirement, hope is not a strategy. As more Australians transition from wealth accumulation to retirement, there are some key factors to consider as they enter the Retirement Risk Zone.
The Retirement Risk Zone is a critical period in the financial life cycle, spanning about 10 years prior to retirement and 15 years after retirement. It’s a crucial time, because when retirement balances are at their peak, they are most vulnerable to a market downturn.
Chart 1: The Retirement Risk Zone
The sequence of returns (sequencing risk) within this period can have a dramatic effect on the longevity of your portfolio. Short-term portfolio losses can have significant long-term effects on retirement savings, compared with similar losses at the early stages of wealth accumulation.
Sequencing risk is amplified as retirement approaches if portfolios are highly weighted to high-risk assets which are more suitable for the accumulation phase. Experiencing a market correction in the Retirement Risk Zone can be very difficult to recover from. If it happens, there are a few options to replace the lost savings – none of which are likely to be acceptable. These include delaying retirement, reducing retirement spend, or simply taking on more investment risk to recover lost returns.
This inherent danger is why portfolio strategies for retirees in the Retirement Risk Zone need to transition towards preserving capital while maintaining a decent income. As you move from accumulating to decumulating wealth, your investment needs and risk profile change. Chasing higher returns decreases in importance and instead receiving income and preserving capital become more important.
Market corrections will happen
Equities are likely to be part of most retirement plans because they provide long-term returns to hedge against rising living expenses, as well as relatively higher levels of income in an ultra-low interest rate environment. However, equities are the worst asset class when it comes to volatility – especially during market corrections.
It should come as no surprise that stock markets correct whenever global growth slows. This has certainly been the case over the past 30 years, during which time there have been nine global slowdowns.
In fact, in the past 84 years – spanning from World War II to the recent COVID-19 crisis – there have been 12 large corrections, which are defined as drawdowns of 20% or more. That’s an average of one big correction every seven years. So, it’s highly likely that the average retiree will experience a major market correction in the 25-year Retirement Risk Zone.
Chart 2: All Ordinaries Price Index Drawdown Profile
Dividend growth expertise
One can hope that retirement occurs without a market correction. If you experience strong rising markets within the Retirement Risk Zone, you will more than likely enjoy a comfortable retirement. However, hope is not a retirement plan. Experiencing a market correction during this period could seriously damage your retirement outcome.
Preparing ahead is the best protection within the Retirement Risk Zone by aligning portfolios to the types of assets suitable for retirement. One strategy that has become popular over the past decade is dividend growth, or equity income. These strategies have capital preservation characteristics to deliver low downside risk to investors and retirees. Higher income is also a key component of many equity income strategies, with a focus on providing greater yield than cash investments. And unlike cash-based income strategies, dividend income has the advantage of providing a hedge against inflation.
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 with a mix of yield and quality companies. It is designed for investors looking for lower risk equity market exposure or those drawing down on their savings.
SWTZ 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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