In our ongoing series of retirement bootcamp webinars I’ve gotten some great questions from participants. They speak to the challenges of planning for retirement and managing finances during retirement.

I’ve provided answers to four of the questions below and offered Morningstar resources to help investors achieve better retirement outcomes. You can find replays of the retirement bootcamp webinars and the associated resources here.

Question: Since market returns have historically exceeded the suggested withdrawal rates then why would I ever run out of money in retirement?

This is a great question and I get this a lot. And to deal with the challenges in retirement it is important to understand the situations where the average returns exceed the withdrawal rate and you still run out of money.

When you are pulling money out of your investment accounts to pay for retirement while a portfolio drops in value your balance can quickly evaporate. When the market recovers there are less assets remaining to go up in value. In extreme market drops this can significantly impact how long a portfolio will last. This is called sequencing risk.

We can consider two scenarios. The average return is the same. The order or sequence of returns is different. The first retiree enjoys the strongest possible start, recording 10 years of 12% returns, followed by a decade of 6% gains, and then breaking even in the final decade. The second retiree experiences the reverse. She endures the weakest possible start, treading water during the first decade of retirement, then posting 6% returns, before finishing with 12% results. The following chart depicts the two investors’ fates.

Sequencing risk

Protecting against the back luck of retiring into a bear market is why there is such a focus on a safe withdrawal rate. Learn more about it on our article on the 4% rule

Question: Given our parents lived to their early nineties we need to long term plan till we are 95+. How do you vary the shares to cash mix in the SMSF portfolio over the 30-35 year period?

This question focuses on the second major risk facing retirees. Longevity risk refers to retirees that happen to live a very long time which means a retirement portfolio must last longer. The longer a portfolio needs to last the higher the returns in retirement need to be. This means more exposure to growth assets like shares that have higher expected returns over the long-term.

One of the many challenging parts of planning for retirement is the interplay between sequencing risk and longevity risk. Simplistically the best way to combat sequencing risk is to lower the volatility of your portfolio with more defensive assets like bonds and cash. This contradicts the best way to set-up a portfolio to combat longevity risk by having more growth assets.

One approach is to figure out a way to not sell low in a bear market while maintaining adequate exposure to growth assets through a bucket portfolio. I’ve outlined this approach in my article on how I’ve used a bucket portfolio for my mother’s retirement and the plan I have for my own. You can read more about it here.

You can also focus on dividends in retirement. You can read about that strategy here and the potential risks. 

Question: What are your thoughts on contributing $120k as a non-concessional contribution at a moment when the market is so high? Better to wait or do $10k a month to dollar cost average?

This question has a little bit of everything in it. Super contributions can be concessional and non-concessional. A concessional contribution is a pre-tax contribution where an investor avoids having income taxed at their marginal tax rate and instead is taxed 15% on a super contribution. This is the most tax effective way to contribute to super. However, there are limits to how much can be contributed. For this financial year the limit is $30,000 which includes any employer contributions to super.

There are however catch-up provisions. If you have unused concessional contributions from the previous rolling five-year period you can contribute the unused concessional contributions if your super balance is less than $500,000. The first step to getting more money into super is to check your eligibility for more concessional contributions. If no longer eligible a non-concessional contribution should be considered.

A non-concessional contribution into super is an after-tax contribution. You pay your marginal tax rate on any income earned and can contribute up to $120,000 into super each year as long as your super balance is below a certain limit. The amount of the non-concessional contribution would be impacted if your super balance is currently above $1.6m and would be prohibited if the balance is over $1.9m.

The advantages of non-concessional contributions is that once the money is in super the tax rate on capital gains and income is lower than it would be outside of super. That can make a big difference over the long-term.

The question is focused on investing in a lump sum or dollar cost averaging which involves parcelling out the money over time. My colleague Shani has written Morningstar’s research on lump sum vs. dollar cost averaging which you can read about here. The summary is that historically the market has gone up most of the time so the best outcome for investors is through lump sum investing.

The times when this approach hasn’t worked is when the market falls significantly after a lump sum investment is made. This is always a risk and the question is alluding to this with the statement that the market at the moment is “so high”.

Is the market set-up for a big fall? I don’t know. And neither does anyone else. Making a decision to go with dollar cost averaging is market timing which traditionally has been very difficult to do well. I think regardless of the ultimate result any benefit from dollar cost averaging would be based on luck while the lump sum approach has a higher probability of being the right call.

Question: Would it not be better investing in a high yield AUS ETF rather than an annuity?

Anytime you consider two different investing approaches or two different investments the question is not which is better. It is which choice is better for you. This may sound like semantics but context is required to evaluate any choice. And the context is what are you trying to accomplish and your attitude towards money and life.

An annuity provides certainty. A lifetime annuity addresses the two major risks that retirees face – sequencing risk and longevity risk - through guaranteed payments that are not based on market movements and continue until death. At this time an annuity provides a higher level of income than most safe withdrawal rates would support. Currently annuity provider Challenger is offering the equivalent of a 4.764% withdrawal rate for women and 5.062% withdrawal rate for men for a lifetime annuity that starts immediately for 65-year-olds with full inflation protection. The difference between gender accounts for the fact that men generally die younger.

In exchange for this certainty an investor gives up upside. In the case of a high yield ETF an investor will have more money and may be able to spend more in retirement as long as markets continue to rise and dividends grow.

The decision to buy an annuity or invest in a dividend ETF is influenced by your financial circumstances. The risks associated with markets can be mitigated by personal circumstances like a fully paid off home, access to the age pension, cash, likelihood of extreme longevity and a myriad of other factors. It is also influenced by your personality. An annuity removes risk and different people respond differently to risk. If each gyration of the market is going to keep you up at night perhaps an annuity would work better. If you are more comfortable with risk it may make sense to keep investing.

Do you have more questions about retirement? Email me at mark.lamonica1@morningstar.com. 

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