The investment returns received just before and after retirement can make a big difference to how long retirement savings will last – highlighting the importance of achieving growth with capital protection.

In the investment world, the saying “it’s the long-term that counts” is often used to dispel fears about market timing. That might be true if your client can keep their money invested for the long term. But what if they need to drawdown their money to maintain their lifestyle in retirement? How can they start spending now without worrying about having to adjust their lifestyle later?

The ‘retirement risk zone’

The seven or so years before and after retirement are known as the ‘retirement risk zone’.  During this time, your client’s savings are at their highest, but it’s also when they’re most vulnerable to market volatility. That’s because there’s less time to recover, and the combination of falling asset prices and capital drawdowns for income compound the impact of a capital loss.  These losses in retirement can have a nasty knock-on effect for retirees, potentially resulting in:

  • Having fewer assets, which makes it harder to recover from those losses
  • Adjusting lifestyle (spending less) to help assets last longer
  • Running out of money sooner than expected, even if markets offer higher returns later in retirement.

What difference can the sequence of returns make?

Sequencing risk refers to the order in which returns are achieved from a particular portfolio. How it impacts a portfolio can differ greatly between an accumulation portfolio with no drawdowns versus a retirement portfolio with regular draws down.

For instance, Chart One shows two accumulation portfolios that have the same expected return, and the same volatility of return, with the order of the returns reversed.

Chart One

Graph by Allianz Retire Plus showing same risk/return metrics

¹ Illustrative purposes only
Source: Macquarie

As you can see, if a person can keep their money invested for the whole period, the order in which they achieve those returns doesn’t matter as the end result is the same.

However, when a retiree is drawing money out of their account every year, the order of the returns can have a massive impact on when the retirement portfolio runs to zero, as shown in Chart Two.

Chart Two

Graph by Allianz Retire Plus showing the drawdown rate indexed to inflation

¹ Illustrative purposes only
² Drawdown 3% of beginning value of $100 indexed to inflation at a rate of 1.5%
Source: Macquarie

One of the retirees runs out of money after 20 years, while the other retiree still has a substantial account balance after 36 years simply because of the sequencing of their returns even though the portfolios had the same risk/return metrics.  This dramatic difference highlights sequencing risks as a significant measure of risk that needs to be addressed in retirement portfolios.

Helping retirees make their money last

The traditional view is that retirees should have a more conservative portfolio with reduced growth assets in order to lower the risk of capital loss. But when we consider that many people fear of running out of money in retirement, this should change the way we define what risk is for a retiree.

Chart Three shows the typical efficient frontier, with risk measured by the volatility of returns:

Chart Three

A graph showing the returns vs risk

Source: Macquarie

As you’d expect, the more growth assets you add to a portfolio, the higher the return expectation and the higher the volatility of returns.

If instead we look at the measure of risk being the number of times that a portfolio will run out of money over a certain period of time, then the chart looks like this:


Chart Four

A graph showing returns pa on growth allocation for portfolio types

Source: Macquarie

This chart shows a conservative portfolio actually has the highest risk of running out of money, while a growth portfolio is the lowest risk portfolio.

What all this is telling us is that retirees still need growth assets in their portfolio to sustain their income requirements. But they also need the right capital protection strategies in place to reduce the impact of sequencing risk.

It’s time for a new approach to building retirement portfolios. The traditional approach—reducing growth assets and mitigating volatility—just doesn’t effectively address the need for retirees to grow their savings in retirement and the key risk to retirement savings, the sequencing of returns.  By applying this new approach, you can tick both of these boxes and help your clients live their best retirement.

This material is issued by Allianz Australia Life Insurance Limited, ABN 27 076 033 782, AFSL 296559. (Allianz Retire+). Allianz Retire+ is a registered business name of Allianz Australia Life Insurance Limited. This information is current as at October 2019 unless otherwise specified. This information has been prepared specifically for authorised financial advisers in Australia, and is not intended for retail investors. This material is for general information purposes only. Any advice provided in this material does not take into account your objectives, financial situation or needs. Before acting on anything contained in this material, you should speak to your financial adviser and consider the appropriateness of the information received, having regard to your objectives, financial situation or needs. No person should rely on the content of this material or act on the basis of anything stated herein. Allianz Retire+ and its related entities, agents or employees do not accept any liability for any loss arising whether directly or indirectly from any use of this material. Past performance is not a reliable indicator of future performance.