When you're saving for retirement and investment markets are volatile, the ups and downs in your retirement savings may affect you psychologically, but they don't immediately affect your lifestyle.
However, when you're in retirement drawing an income from a living annuity, it's a different story. Your income is subject to that volatility.
You need to invest in equities to get sufficient growth to see you through potentially many years in retirement — but how to generate a reliable, consistent income from your investments when they are volatile is a dilemma.
The investment industry and advisers are, however, beginning to focus on strategies to help retirees who are drawing a pension from their investments. At the Investment Forum conferences held this week in Cape Town and Sandton, two managers addressed the issue and a new retirement income qualification for advisers is under development.
Marc Thomas, head of marketing and distribution at Bridge Fund Managers, says managing your money for an income in retirement is way more complex than saving for retirement, when you typically focus on growth and accumulating as much capital as possible before your retirement date.
Retirees drawing an income from their investments in a living annuity, however, must focus on getting income and growth. Your income has to grow, because you may live up to 30 years in retirement. And your portfolio doesn't have a tailwind - of money going in — to cushion the blow of volatility, he says. This exacerbates volatility and introduces risks, such as the risk involved in the "sequence of return".
Sequence of return risk is the risk that if your living annuity investments earn low or negative returns in the early years of your retirement while you draw an income, good returns later may not be enough to prevent you from running out of capital.
And sequence risk matters more than the average returns you earn when you are in retirement drawing an income, Thomas told delegates to the Investment Forum.
The level of income you can safely draw from your investments without depleting them is affected far less by the average returns you earn over the 30 years (it explains only 32% of the variance) and much more by the five-year returns within those 30-year periods (this explains 95% of the variation in the level of income), he says.
"The difference between those two is the sequence in which returns are delivered - which five years you get and when: the good ones first or the poor ones? The first five years and 10 years have the most important impact on the rate you can withdraw," Thomas says.
He adds that the investment industry is not only obsessed with average returns, but also with managing volatility and protecting you from investment losses when these strategies do not have enough firepower to solve retirees' problems with the sequence of returns.
Instead you need "purpose-built strategies" that "deliver reliable, growing income despite short-term market volatility and uncertainty".
Typically advisers help retirees determine the level of income they can draw based on returns over the past year, but you need to be able to plan your income without worrying about short-term performance.
You also need to be able to protect your capital from being depleted in periods of poor returns.
"We all know intuitively that when the capital value is falling, taking money out every month is damaging to the portfolio. And even if a recovery comes 12 months later, you will be coming off a much lower base and find yourself in a hole which is difficult to get out of."
Bridge has set up investments that focus on producing reliable income for retirees to draw on but also to grow the capital that provides that income.
It has also developed tools for advisers to help retirees customise their own asset allocation based on their income needs, inflation, volatility in the markets and their investment time horizons. These tools also help manage the withdrawals and income flows from investment "buckets" without introducing sequence of return risk when your funds are moved between portfolios.
Another investment manager focusing on retirees' income needs is CoreShares, which provides low-cost index tracking investments. CoreShares announced at the Investment Forum that it planned to launch a low-equity, multi-asset fund for retirees drawing an income from a living annuity.
Chris Rule, head of product at passive manager CoreShares, says most multi-asset funds are focused on maximum returns rather than delivering predictable outcomes suited to drawing an income.
They manage the risk of certain events rather than the risk of not meeting an investment target, which investors who need to draw an income face.
CoreShares will use its research on the optimal asset class mix in the multi-asset fund that aims to achieve an inflation plus 3% target over all rolling three-year periods with 70% consistency — much higher than the 34% success rate that the average low-equity fund currently achieves.
Financial advisers all over the world have focused on how much retirement savings you accumulate, and have not given enough planning and time to managing the more financially challenging "decumulation" phase, says Derek Smorenburg, the CEO and founder of the South African Independent Financial Advisors Association, says.
Smorenburg is the driving force behind the development of a post-retirement planning course and qualification for local advisers. He hopes it will be rolled out this year.