Two potential areas of trouble in a retirement portfolio in the current climate are concentration of risk around Australian property trades and accelerated draw-down of retirement assets due to low yields on offer on fixed income.
One particular area where we often notice concentrated risk in retirement portfolios is in residential property, both specifically within self-managed super funds and also as a large component of the total assets of many people entering retirement. Currently, yields in domestic residential property are very low, and valuations are very high. With most investors having a direct stake in the asset class, and also considering ancillary trades around that, such as investments through banks and some of the REIT providers, it’s a stacked bet on one very expensive trade.
That approach has worked well over the last two decades or so, but in recent years we received a warning shot across the bow in the form of a small market correction. Although investors with a long horizon can take this kind of correction in stride, retirement investors should be very cautious about the sequencing risk associated with this kind of market event.
Another point of concern is the effect of low-yield world on retirement incomes. The cash rate in Australia currently stands at 0.75%, with further cuts expected early this year, and fixed income assets are returning yields at record lows. Retirees are having to draw down on their asset base in order to generate income from these asset classes. This is a particular risk inherent to some fixed allocations in the current economic climate and we think it needs to be taken into consideration, given the likelihood that the current low-yield rate will continue for some time to come.
Similarly, cash exposure needs to be carefully managed to ensure inflation and financial repression doesn’t eat into your asset base. One way investors can manage this risk is to tactically allocate to higher yield asset classes such as Australian equities, With the benefits of franking, Australian equities have been able to achieve over 6% income over the past decade since 2009 and has also delivered some capital growth1.
There’s also the issue of longevity risk to consider. You should plan to live long and better while also managing your assets to cover that eventuality that you do live until a very old age. Retirement investors don’t want to outlive the value of their portfolio. Investing in equities makes sense if investors can look through the short-term volatility.
These are key areas that investors should consider when addressing risk in their retirement portfolios.
Subscribe below to Market Watch to receive my latest articlesDermot Ryan, Co-Portfolio Manager (Income)
1 AMP Capital
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