How to avoid this common retirement challenge
October 2023
Saving enough superannuation is just the first step in enjoying a comfortable retirement. It’s just as important to minimise the risk of your capital running out earlier than planned.
Proper budgeting and optimising returns are obvious issues to consider. But there’s another challenge that can catch out retirees who are unprepared for the inevitable volatility of financial markets.
The problem is many retirement plans assume super will return, say, 7% on average over time. That can easily be taken to mean funds will return 7% year in, year out.
But financial markets don't behave in such a predictable pattern. Some years they soar. In others, they fall sharply or just move sideways. And the sequence of those good and bad years – not the average return over time – determines how long super will ultimately last once you begin to draw on it.
The real-life consequences of this mathematics are telling. In fact, it’s possible a savings pot could run out years earlier than anticipated if there is a big market downturn at the beginning of a person’s retirement.
Two people with the same amount at retirement could even have the same average return over 25 years and draw down the exact same income – but one could run out of super before the other if the above scenario played out in their retirement.
Consider two hypothetical retirees with a $450,000 super balance who draw $30,000 annual income from it (indexed for inflation). Both are invested in the same way, with an average return of 7% over 25 years. One runs out of super seven years earlier than the other due to the sequence of their annual returns.
Click image to enlarge
This example is provided for illustrative purposes only.
Source: Russell Investments. Retiree 1: Annual return/inflation from December 1997 based on indicative portfolio of 50% Australian bonds, 50% Australian Shares. Returns based on S&P/ASX 300 Accumulation Index and UBS/Bloomberg AusBond Composite 0+ Yr Index. Retiree 2: Same returns/inflation in reverse chronological order. Inflation based on Annual Consumer Price Index (CPI) sourced from ABS.
This kind of risk poses the biggest threat to investors close to, or early, in retirement when their savings are likely at their maximum value. The good news is that different strategies are adopted by financial advisers to offset the potential impact and make sure clients can weather market ups and downs.
It’s important to consider this challenge ahead of retirement – so speak to your adviser for more information.
Past performance is not a reliable indicator of future performance.
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