The fear of losing money can become a self-fulfilling prophecy for many retirees. Here’s how you can help your clients stay in control of their retirement income – even during the COVID-19 crisis.

When you’re building a retiree client’s investment portfolio, what do you take into account? Obviously, you’ll look at the client’s financial objectives, and carefully weigh them up against factors like inflation, market volatility and longevity risk.

But do you also consider the risks that can arise from the client’s own behavioural biases?

Like any investors, retirees are driven by a range of unconscious biases that can negatively impact their financial decisions. One of the most crippling is loss aversion: when a particular course of action is taken to avoid a perceived loss. In retirement loss aversion can morph into hyper-loss aversion (HLA) and for some investors this can start a vicious cycle, which, ironically, may lead to further losses.

The fear factor

While no two retirees are the same, it’s safe to say that most share a common goal: to generate enough money so they can enjoy life after work. It’s therefore no surprise that many retirees worry their savings won’t last the distance. In fact, research shows that around 60% of Australians aged between 50 and 70 share this concern to some degree.¹

One of the reasons behind this fear is that we’re living longer (although of course, this has a definite upside too). In 1960, for instance, the average life expectancy for a 65 year old Australian man was 78 and for an Australian woman it was 81. Fast forward 60 years to now and, with ever increasing mortality improvements, the life expectancy for 65-year-old Australians is 85 for men and 87 for women.²

So for someone who’s just turned 65 and is about to retire, they’ll want to make sure their retirement savings will last at least 20 years. That’s a significant jump on the 13–16 year retirement that a person leaving the workforce in 1960 could expect. And for women in particular, who tend to retire with less money but live longer than men, the prospect of a lengthy retirement can be especially daunting.

The other worry that haunts many retirees stems from sequencing risk; if they experience a market downturn close to or during retirement, their opportunity to recoup their losses by staying invested for the long term becomes a thing of the past. 

Tough times = rash decisions

The theory behind HLA is that the average investor dreads a financial loss twice as much as they value a gain, but this fear intensifies as they approach retirement. As a result, retirees dread a loss ten times more than they value a gain.³ This can lead to hasty financial decisions that end up doing them more harm than good.

“During periods of economic uncertainty, hyper loss aversion can drive investors to take a more conservative investment approach than they would otherwise”

Such was the case during the Global Financial Crisis, when panicked investors moved their assets into cash, crystallising their losses at the worst possible time.

As COVID-19 continues to send shockwaves through global sharemarkets, pre-retirees and retirees are once again making similar choices. In fact, during the first quarter of 2020, rattled investors pulled money from every asset class except cash.⁴

The irony is that investing solely in cash may in fact cause the scenario retirees fear most: running out of money during their lifetime. As their cash-only investments fail to keep up with inflation, they’re forced to draw on and eventually deplete all their retirement income.

Backing a sure thing

Fear of loss also means that most of us have an inherent dislike to taking a risky bet. This notion is supported by ‘utility theory’, an economic concept that was first posed by Swiss mathematician Daniel Bernoulli in 1738.

The Benoulli test shows that when making a financial decision that involves uncertainty, most people tend to put their personal satisfaction and comfort ahead of the chance to make more money. In other words, we’re willing to pay a premium to achieve a safer, more certain outcome.

Incidentally, we recently ran an experiment based on the Benoulli test with a group of financial advisers. We offered them each a choice: either we’d donate a guaranteed amount of money to their favourite charity, or else they could gamble on getting a potentially higher donation. Three-quarters of our participants went with the first option because of the certainty it offered.

If utility theory can be applied to our decisions around donating to charity, imagine what it means for retirees who have much more at stake personally. It doesn’t take a mathematician to realise that retirees are likely to forgo a financial gain in favour of a having a known amount of money that will allow them to live comfortably. Achieving this certainty should be at the heart of all retirement portfolios.

How you can help

To meet their ongoing income requirements, retirees need a fairly substantial exposure to growth assets like shares – particularly now that interest rates are at an all-time low. But they also need to apply protective strategies to secure their capital against sequencing risk.

So how can you help your retiree clients overcome HLA and look beyond low-yield investments? One solution is to use tools and products specifically developed for retiree investors.

For example, Future Safe by Allianz Retire+, is a seven-year investment solution designed to safeguard investors from sequencing risk. As well as providing growth through access to market-linked returns, it can help protect retirees against losses in a falling market. This is because Future Safe allows investors to set a floor on the level of loss they’re willing to accept if markets fall.

By shielding your clients from excessive losses, you’ll give them the confidence to fund the retirement lifestyle they want. Just as importantly, you’ll help alleviate their fears so they have peace of mind to enjoy it too.

1 National Seniors Australia, Feeling financially comfortable, 2019.
2Australian Bureau of Statistics, Life tables, states, territories and Australia, 2016–18.
3Gachter, Johnson, Hermann, Individual-level loss aversion in riskless and risky choices, 2010.
4Allianz Retire+, Investfit projections, March 2020.