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Financial Happenings Blog
Monday, March 24 2008

Saturday's Australian included an article from Geoffrey Newman, 'Seeing red - retirees have a lot at stake when the stock exchange takes a tumble'.  There is no doubting the assertion contained in the headline.  As retirees move from relying on personal income earning activities such as work and small business ownership to a more passive approach of income earning through investments.  For most retirees, to achieve the income levels they require (after taking out the effect of inflation) will involve investing in volatile asset classes such as stock markets.


But how much should a retiree have invested this way and what is the real impact on their investments if stock markets fall?


The article written by Newman quotes Hans Kunnen, head of investment research at Colonial First State.  Kunnen suggests that most good financial advisers should be putting two to three years of income in cash and the rest in growth assets.  We disagree slightly with Kunnen and suggest that at least four years is a more realistic allocation to non-volatile assets such as cash and fixed interest securities.  Here's why.


As a minimum, investors should be looking to protect against having to sell volatile shares for a period of 7 years.  This does not totally count out having to sell down volatile assets after a long period of downward movement, there have been bear markets for longer than 7 years, but the risk of having to do so is significantly reduced.


By holding four years of income in non-volatile assets, you are able to draw down on these assets plus have these assets added to through income from investment returns.  At present levels, cash interest is running at approximately 7%, fixed income 7.5%, Australian share dividends 4.1% plus 1.4% franking credits i.e. 5.5% in total, international share dividends of 3% and listed property distributions of 7.3%.


Similar income returns going forward should see non-volatile assets last for at least 7 years before needing to contemplate the possibility of selling down volatile assets during a bear market.


Therefore, our approach at A Clear Direction is to focus on income planning with our clients.  The key question we ask is how much income a retiree will require in retirement.  From this point we then determine what allocation of assets will be required to produce this amount of income without needing to sell volatile assets such as Australian shares, property (direct or through listed property trusts) or international shares.  In particular how much of the portfolio should be held in cash and fixed interest securities.


Through this process of determining asset allocations when establishing and maintaining an investment portfolio, investors, especially retirees, will be putting in place a strategy to be able to ride out bear markets without actually realising any capital losses by selling volatile investments at the worst possible time.  The paper value of their investments will fall but paper values don't matter until they become realised through changing non-cash items into cash.  Based on historical evidence, volatile assets will bounce back in value and restore, and then improve their value.


This approach does not make investors immune from the emotions caused by rough times like we are experiencing now, but it sure helps them sleep a bit easier at night.



Scott Keefer

Posted by: Scott Keefer AT 06:12 pm   |  Permalink   |  Email
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