Few investment metaphors are as misleading as the retirement “nest egg”. Too many retirees believe their savings are fragile and to be preserved at all costs when in fact the purpose of them is to use them to provide an income in retirement. .
But as evidenced in Callaghan’s fact-based Retirement Income Review (RIR), a reluctance to draw down on capital in favour of preserving the nest egg has consequences. Many retirees live too frugally because they lack the confidence to use their superannuation savings, instead they downgrade their lifestyle accordingly, potentially living below the poverty line.
As a business, we’ve seen this problem first-hand. We surveyed¹ over a thousand retirees in the first half of 2020 to understand how COVID-19 affected their wellbeing.
The results were stark. Three quarters of respondents did not know how long their money would last in retirement; half said they did not feel financially secure; but this is the key statistic that stands out: two thirds said that they were only buying necessities. That is a shocking fact, which extends further than the COVID impact.
These statistics are also consistent with our earlier research undertaken in 2019, where we found retirees were still scarred by the Global Financial Crisis and terrified at drawing down faster on their capital.
Their goal wasn’t high returns or a luxurious retirement. They just didn’t want to be hit by unexpected costs they potentially couldn’t cover. They wanted greater certainty that their money would last, peace of mind and to sleep easier at night. And they wanted to enjoy their retirement, not feel they were on a sharemarket rollercoaster and at the mercy of global markets.
The Callaghan report further confirmed something that we have long believed – we’ve been so focussed on cultivating the nest egg and delivering wealth accumulation strategies that support it, little attention has been paid to the drawdown phase.
The investment industry has not met this need. Asset managers and super funds have focused too much on wealth-accumulation strategies and not enough on the drawdown phase. This lack of innovation hasn’t left retirees with many investment options, so it comes as no great surprise that some would rather live on a minuscule yield from term deposits than draw down confidently on their capital.
Understandably, some retirees are reluctant to spend part of their capital because they are living longer and need their savings to last. But longevity risk is only part of the problem.
Volatility of returns in equities also fuels this need to preserve capital. Many retirees watched their sharemarket investments plunge during the GFC and again during COVID-19. They worry about using their equity capital when another financial shock could erode its value.
“Ultra-low interest rates only amplify this problem by punishing retirees who have too much of their savings in term deposits. Also, low rates force investors to take more risk to earn higher yield.”
Higher allocation to growth assets needed
Current low rates are not without long term implications and are, no doubt, playing into the ‘nest egg mind-set’ of those in retirement.
The fact is, retirees will need to hold more growth assets (equities) and fewer defensive assets (cash and fixed interest) to earn a sufficient return to sustain their ever-increasing lifespan. The days of the traditional 50/50 split between equities and cash or fixed interest won’t be enough.
The upshot is retirees need more equity exposure at a time of heightened sharemarket volatility. Callan Associates research² found portfolios must contend with six times as much volatility (standard deviation) to earn the same returns as 20 years ago.
Consider how this affects retirees. Low returns on defensive assets mean they need to own more growth assets to earn a sufficient return. But with that comes higher risk given the sharemarket volatility and occasional wild swings in wealth that terrify many and don’t promote a sense of confidence in drawdown behaviour.
The result: retirees adjusting to ever-lower income returns on their savings, having poorer standards of living, and unnecessarily preserving too much of their capital.
Protection strategies needed
Observations in the report also pointed to the age pension playing an important role in supplementing the income of low to middle income earners. It was also deemed a “buffer” against outliving savings or being subject to market volatility. A longevity safety net.
While the current level of income support may not be deemed as an attractive proposition to survive off in retirement, the concept of a safety net is an important one because of what it enables: a greater sense of confidence and certainty.
The behavioural attributes called out in the RIR of retirees living frugally, drawing down SIS minimums and dying with high percentages of super balances – or more aptly, ‘retirement income’ – in fact suggests that there is high demand for better, more innovative investment choices for retirees.
I believe the use of protected equity products for retirees goes to the heart of this problem. Just as retirees insure their homes, so too should they be able to protect (fully or partly) their equities exposure in a cost-effective, convenient way.
Of course, nobody wants retirees to squander their savings through ill-conceived capital drawdowns. Or to use such a strategy without discussing it first with their financial adviser. Nor should we underestimate the importance that many retirees place on leaving part of their savings to loved ones, through capital preservation.
This is a question of balance. And about helping retirees tactically use their capital when rates are low, through innovative protection strategies that are long overdue in this market.
We should also never underestimate the importance of delivering ‘peace of mind’ if we are ever going to help retirees maximise the use of their nest egg in retirement.
Allianz Retire+ offers Future Safe, an innovative retirement investment product that seeks to adequately protect the equities component of a portfolio, utilising a Cap and Floor protection strategy.
1Based on Allianz Retire+ survey in March and April 2020 of 1,007 current and prospective retirees.
2Callan Associates, “Risky Business”, 2019