Funding retirement income in a low interest rate environment
While a traditional bank deposit is generally regarded as one of the safest forms of investment, it also currently offers amongst the lowest returns. For those relying on bank deposits to fund their retirement income, the current record low interest rate environment offers little reward.
For those approaching retirement, low interest rates could mean having to rethink their retirement goals, retirement timeframe and potential sources of retirement income. For existing retirees, it could mean having to re-assess their goals. Simply put: low interest rates means more capital is required to fund future income needs.
This raises the question – if interest rates stay low for the foreseeable future, how can you fund the retirement lifestyle you’d hoped for?
Regardless of whether you are preparing for retirement, or are already retired, the answer lies in focusing on factors you can control, rather than those you cannot. Whilst there are many aspects of investing that can’t be reliably predicted, there are many factors you can control, including:
- how much you spend;
- how much you save;
- how much investment risk you are prepared to accept;
- how you structure your investments; and
- how much you pay in fees.
For those still working, it could mean adjusting discretionary spending, so that more funds can be used to boost retirement savings, or additional mortgage payments can be made to reduce the amount owing, or a combination of both. Less spending now means more money for later.
For self-funded retirees, it could mean adjusting discretionary spending by taking fewer ‘big’ holidays or by considering the Age Pension in their future planning.
Inevitably, investors may feel compelled to move further along the risk curve to seek out the retirement income they desire. In other words, they may seek to diversify away from cash and invest a higher percentage of their capital in alternative forms of income producing assets – such as shares, property and infrastructure. This is often referred to as the ‘search for yield’.
Cash vs Alternative Income Assets
The cash rate in Australia is currently 1.50%, with some institutions offering around 3.00% depending on the deposit amount and timeframe. Compare this to shares, where it is possible to receive a 6.00% return (or more), often with the benefits of franking credits.
There are, of course, risks associated with growth assets that can’t simply be ignored, and investors need to feel comfortable that the value of their portfolio will fluctuate over time, as the assets respond to prevailing market conditions. Whilst a regular dividend can help to offset the impact of any future share price falls, there is no guarantee that dividends will continue to be paid at the same rate.
Managing investment risks can be achieved by:
- buying and holding quality assets;
- being prepared to stay invested for the long term; and
- being prepared to ‘capitalise’ on over-heated markets.
Structuring your Assets
The overall structure you employ is the foundation to your portfolio and impacts the net return you receive. Quality assets, poorly structured, can lead to lower real returns.
For self-funded retirees, the decision to hold assets via a super fund or account based pension, or in their individual names can lead to very different results, in the form of:
- Returns – some structures don’t pay tax on earnings, so holding assets in the right structure can lead to higher returns.
- Benefits – some structures offer Centrelink exemptions, so holding assets in the right structure can lead to increased entitlements.
Understanding the difference between structures, and how these relate to you, can be complicated as they relate to an individual’s personal circumstances. This is one area that is definitely not “one size fits all.”
The fees you pay, whether direct or indirect, will also impact the net return you receive and can make a significant difference over the long term. Fees can generally be categorised into three areas:
It is important to have a good understanding of the total fees you are paying, to be satisfied that you are getting “value for money.”
As outlined above, it is clear that there are many factors to consider when it comes to deciding which approach is best for you. Now, more than ever, due to the current low interest rate environment, it’s worth reviewing your overall position to determine whether your current strategy remains relevant to your needs and lifestyle. Please contact us to discuss your particular situation.