Retirement. The “R” word that many would prefer to delay thinking about until it’s inevitable. I recently had the opportunity to discuss the meaning of retirement planning success with a client. Much of the thought process that she had undergone prior to our discussion was focused on the accumulation phase – making sure that there’s enough saved in the retirement nest egg. But as one inches closer to the finishing line, the focus will need to shift towards the more interesting, albeit daunting, task of ensuring that whatever has been accumulated is sufficient to last the rest of our ever-increasing post retirement years.
Looking at the environment that we’re facing today, where the cost of living seems to be escalating to worrying levels, one can’t help but to check and recheck their financial numbers before the income tap is finally switched off with retirement.
If we want to increase the chances of our retirement planning success, a well thought-through drawdown strategy should be considered, at least 2-3 years before D-Day comes along. Here are some thoughts to get you going.
Before we’re able to effectively plan our retirement drawdown strategy, we will first need to be clear on what assets we have that can be earmarked for this purpose. As such, an asset listing and tagging exercise is the first step.
Common assets that have been squirrelled away over many working years for retirement would include savings and investments in one’s Employee Provident Fund (EPF) account, bank deposits, properties, stocks, Amanah Saham, unit trust funds, endowment insurance policies and the like. A growing number of people are also investing in alternative assets like cryptocurrencies, private equity and peer-to-peer lending too.
Having a complete listing of available assets and tagging them by financial goals will help us better understand the likelihood of achieving those desired objectives. Otherwise, there’s a chance that we might end up achieving certain goals at the expense of others.
To ensure what we have is enough to cover our expenses in retirement, we will first need to know how much we incur today. If you haven’t already worked out your current expenses,this will be a good time to do so.
In retirement, certain expenses will go up while others will decrease. You might spend less on work related travel or attire, but you might spend more on health supplements, holidays and social activities. If you find working this out a daunting task, then a simple rule of thumb is to budget 70% of your current expenses in retirement.
It’s not all downhill upon retirement, especially for those among us who aspire to retire early. We may have a bucket list of places to go and things to do with all the time that we will have in retirement.
Do you wish travel extensively or take up new hobbies? Do you have some long overdue home renovations or even a plan to relocate to a smaller home? Some of us might like to make some provisions to partially assist with the tertiary education funding for our grandchildren or help with some charitable causes. Add these goals to your list and put a financial number and expected timeline to them.
A major concern for retirees is unexpected expenses. Some of these can be planned (with funding set aside accordingly), while others might need to be considered more carefully and risk mitigation steps may need to be put in place.
Top of mind for most retirees would be medical funding, especially on the backdrop of the continuously high medical cost inflation these days. Do you have a comprehensive medical card in place with the appropriate daily room and board, annual and lifetime limits? If this is no longer an option (due to high premium cost or pre-existing medical conditions), you may need to be realistic and rely on government healthcare services as your primary medical provider.
Another factor that is of concern to retirees is inflation. It’s unfortunate that inflation is rearing its ugly head the world over nowadays. Hence, the cost of living for retirees is going up quite drastically. As such, some adjustments to your retirement living expenses might be required to minimise this impact on your lifestyle where possible.
Once retired, you will need a buffer to ensure that the ups and downs associated with investments will not affect your lifestyle or ability to meet other short-term goals.
Commonly termed as the cash reserve, these are funds set aside in stable assets such as bank deposits, capital protected accounts or short- term money market instruments. Ideally one should have between 2-3 years of annual expenses and the cost of any financial goals due during this period as cash reserves.
Now that you’ve considered your financial goals, funding needs and potential risks, how do you continue to make the most of the assets you’ve accumulated to help you achieve your desired retirement?
During retirement, most people tend to focus on income generated by the assets held. For example, an investment property can provide rental income while EPF savings will provide annual dividends. Similarly, stocks may be able to pay good dividends and bank fixed deposits will provide an interest income over the placement period.
While income generation is important, it’s equally important to allow your investable assets the opportunity for capital growth to keep pace with inflation as well. Otherwise, you might end up relying heavily on the drawdown of capital if income generated is insufficient. An accelerated drawdown of principal, especially in your early retirement years, will have a long-term negative impact on your funding sustainability.
When investing for retirement, you should continue to have a combination of different asset classes to help you ride out the different investment market cycles. Although it’s not the intention of this article to discuss safe withdrawal rates, it’s worth mentioning that commonly used assumptions include the 4% rule – ie one should invest equally in equities and bonds and can withdraw 4% of your investable amount yearly while adjusting for inflation. Do take note that these assumptions are US centric and might need to be adjusted to the local environment.
As investment returns fluctuate, it’s worth to consider the retirement bucket approach to investing. In simple terms, you can think of investing in three buckets. Bucket One represents your cash reserves for the immediate 2-3 years of living expenses and funding of any short- term financial goals. Funds here are placed in safer assets with minimal price fluctuations.
Bucket Two will comprise of assets that can be held longer to cover the next 7-10 years of expenses, while generating income and capital growth that can be used to replenish Bucket One as you go along. Investments here would include EPF, stocks and high yield bonds, among others.
Lastly, Bucket Three comprises of long-term assets that can be held beyond 10 years and have good capital growth potential (think property assets, alternative assets and your own business). Income and capital growth from Bucket Three can then be utilised to replenish Bucket Two in the same way that Bucket Two replenishes Bucket One.
In conclusion, most of us will spend anywhere between 20-30 years in retirement. As such, planning for this long journey should be given more attention. The sooner you start the process, the more time you have to make the necessary adjustments for the transition to be as smooth as possible.
Remember that retirement is not a checkpoint but rather a lifestyle. As such, consider having something to retire into, rather than to retire from.
First published in Smart Investor 09/10, 2022 Issue
Director of Financial Planning at Finwealth Management Sdn Bhd