You only live once
‘You only live once.’ This is what you are told when people think you are worrying too much about the future and not living ‘in the now’. However, the same expression could easily be used when talking about retirement planning. What happens in the future may be very different to what was expected to happen and the problem is you only live once. The key to maximising the chances of investment success to aid your retirement planning is to focus on what could go wrong and then make changes to mitigate those risks.
The starting point for any retirement plan is to understand your multiple objectives, such as avoiding living in poverty once you stop gainful employment, achieving a certain lifestyle and, possibly, passing wealth onto the next generation. Just acknowledging these different aims can focus your mind. You want to minimise the probability of being unable to meet required expenses, while also increasing the probability of growing your future income stream or wealth. Obviously, the more you save, the more likely you will be able to meet all three objectives, but the way you invest would potentially differ for each objective.
For instance, equities would be a good place to start if you want to maximise investment returns to build your expected wealth. However, relying solely on equities might be a bad thing when it comes to achieving your minimum income needs – what happens if the next ‘Great Depression’ hits just as you are about to retire such that your wealth plummets and bond yields collapse close to zero?
Therefore, it is critical to spend at least part of your time stress-testing your portfolio against extreme outcomes. I believe this will help you in two ways. First, you will likely have a more robust portfolio that can weather extreme market fluctuations and yet benefit from any uptrends. Second, you are less likely to panic when markets sell-off sharply because your fear of not being able to meet your needs has been drastically reduced. This ability to not over-react in the face of sharp market declines can lead you to outperform the vast majority of investors.
So where do you start given there are an infinite number of scenarios? In the current environment, the way to deal with this is to simplify into 3 broad scenarios: 1) low (but positive) inflation, 2) deflation and 3) high inflation.
The low inflation environment is what we would today deem to be ‘normal’. Ever since the late 1970s, we have got used to major central banks changing interest rates to keep inflation under control and avoid deflation. In this environment, a core investment allocation of diversified stocks, bonds and gold should stand you in good stead, at least if you stay the course.
The other two scenarios are much tougher to manage. Under a deflation scenario, cash is a great asset because it goes up in value over time. Very high-quality bonds, especially those with long maturities, will tend to do even better. Historically, lengthy periods of deflation have not necessarily been bad for stocks, but given the high level of debts that most companies face today, especially after the pandemic, I would argue that most stocks would likely struggle in this scenario, as would property.
The high inflation environment is the reverse. High quality bonds and cash would likely lose purchasing power. There would be mixed implications for stocks. Over the long term, normally stocks more than hold their purchasing power. High inflation would erode the value of their debt, putting them on a more sustainable future. However, this assumes companies survive the sharp increase in funding costs as central banks raise interest rates dramatically to try to bring inflation under control. Property would likely also do well over the long run under this scenario, although property owners with significant debt on their real estate holdings could be forced to sell, potentially putting downward pressure in the short term.
As you can see, the recommendations under the different scenarios vary dramatically. In an ideal world, you would build three different portfolios such that any one of them would be able to generate enough to achieve your financial goals. Of course, for most of us, that is not possible, so we have to make trade-offs. This is where identifying the difference between what you need for retirement and what you want for retirement might help you prioritise your investment allocations within your portfolio, without excessively compromising on your dreams.
Partnership Strategy | Asia-Pac Emerging Markets | HealthTech x WellBeing Eco-System
3 年Inspiring perspective!
Fundraiser for businesses | Overseas loans to Vietnam consultancy | Fintech | Crypto enthusiast
3 年Great article, many thanks Mr Steve Brice
National Sales Head- at Abakkus Asset Manager LLP
3 年Bang on n crisp as ever - Chalking out the well thought strategy basis the risk appetite n staying the course will hold the retiree in good stead