New approach needed for retiree income

As interest rates worldwide reach record lows, retirees are taking on more risk to earn enough investment income to live on – a strategy that could permanently damage their wealth, Allianz Retire+ chief executive Matt Rady has warned.

“The latest rate cut is another blow for retirees,” Mr Rady said.

“Some retirees are investing in shares to earn higher yield – and are left wide open to high market risk. Another financial shock could be financially catastrophic for them.”

The company noted retirees with savings in cash and bank term deposits are barely earning a positive return on their money after inflation.

Further, retirees face comparatively high deeming rates, suggesting many may be going backwards by way of being means tested on income they can’t achieve in this environment.

In Australian shares, RBA analysis has shown the average dividend yield was around 4.5 per cent in 2019, down from 6-7 per cent in previous years. Yields are likely to be lower because of dividend cuts and cancellations during COVID.

“Retirees are being forced up the risk curve in the search for yield,” Mr Rady said.

“They are in a no win situation. Returns from cash and bonds are too low to fund a dignified retirement. And high sharemarket volatility can damage their financial and physical wellbeing.”

Retirees need tools to navigate the “new normal” of low rates that the RBA expects to persist for at least three years, Mr Rady commented.

“Traditional portfolio-construction approaches for retirees are becoming increasingly less effective,” he said.

“What worked in the past in retirement investing isn’t cutting it today.”

There are said to be two main flaws with current portfolio approaches for retirees. The first is using “volatility” to define risk.

“Most retirees don’t care about volatility or standard deviations. Their greatest risk is running out of money during retirement,” Mr Rady said.

With Lonsec Investment Consulting, Allianz Retire+ has challenged the appropriate measure of risk for retirees – an approach it calls the “Retirement Frontier”.

“For years, retirees have been told to hold more defensive assets (bonds, cash) and fewer growth assets (equities) as they age,” Mr Rady said.

”But that theory is now blown out of the water because it consigns them to low returns and a higher risk of running out of money.”

The second flaw is an inadequate response to share market volatility. Portfolios must contend with almost six times as much volatility to generate the same returns as 20 years ago, according to Callan research.

“Retirees have to hold a lot more growth assets to generate the same return as previous years,” Mr Rady said.

“But that exposes their portfolio to much higher return uncertainty at a time in their life when they have less capacity to recover from financial setbacks.”

Higher volatility also increases sequencing risk – the order and timing of returns – for retirees.

“Those nearing or just in retirement, who held more shares for yield, watched the value of their shares tumble in March as the pandemic erupted,” Mr Rady stated.

“Sadly, some will never fully recover those losses because their portfolio was in the wrong place at the wrong time.”

Heightened loss-aversion is another factor. Research has shown retirees feel the pain of a loss 10 times more than joy of a gain.

“Allianz Retire+ surveys show many retirees worry about potential losses on their share investments,” Mr Rady commented.

“Many are self-insuring against the risks of running out of money by living frugally, or they reluctantly draw down on their money. It shouldn’t be like that: retirees should be able to invest in the sharemarket with confidence and enjoy their retirement.”

Financial advisers should look to protect retiree capital in the sharemarket, the chief added. But some advisers have shunned protected style equity linked products in the past.

“As retirees hold more growth assets, protected equity strategies must be embedded within portfolios, to better manage volatility and all the problems it creates,” Mr Rady said.

“Historically, products with a protection element have been costly, requiring investors to sacrifice too much upside, or have been offered by product issuers that are not well known.”

He has pointed to a new breed of retirement product that can provide retirees with a greater degree of certainty, while specifically addressing the features retirees are seeking in their investments.

“We are seeing a lot of progressive advisers use our equity linked product with inbuilt protection to gain exposure to higher yield from Australian and global shares, while minimising downside risk of uncertainty for their retiree clients,” Mr Rady said.

“We think it’s an attractive proposition: exposure to growth with inbuilt protection, at the cost of 85 basis points per year. That’s less than the cost of most managed funds.”