The Perfect Week In Retirement

When we work with clients on their retirement planning, we often ask them to complete an exercise we call the ‘perfect week’.

In this exercise, clients are asked to map out what the perfect week looks like for them in retirement. We create a grid with the days of the week along the top and we divide each day into an AM, PM and evening slot, making a total of 21 ‘slots’ to fill for the week.

Most clients find this exercise fairly simple. Most of us have a pretty good idea about what we would like to do for a week in the ideal world.

Most people will build in some form of travel (perhaps spending the whole of their perfect week on holiday). There will often be meals out with family and friends and ‘experience’ activities like going to the theatre or sailing.

This exercise is incredibly valuable, but it is not the full story.

Retirement is about so much more than just a single week.

As such, we then ask clients to think about repeating this exercise 52 times for each week in the year (to be clear, this is a theoretical exercise – we don’t ask people to actually fill in 52 perfect week sheets).

At this point, people are often a little stuck. It is really easy to visualise a single week or even two or three weeks, but planning out a whole year is a bit harder.

Most people don’t want to (or couldn’t afford to) be on holiday all of the time, so some more thought is required to map out a year.

Once people have given some thought to the 1-year picture, we then ask them to repeat this exercise 30 or 40 more times. This is because there is now a very real possibility that retirement could last 30, 40 or dare I say 50 years for some people.

Thats a total of between 1560 (30 years) and 2600 (50 years) weeks. That’s a long time to plan for.

But plan for it we must. Research has shown that those people who spend significant time planning their retirement are quantifiably happier when they actually do retire than people who have done very little or no planning.

The irony here is that the average American (and one assumes the average person in the UK also) spends longer planning a 2 week holiday than they do a 30 year retirement!

If we are to live a long, and more importantly happy, retirement, we really must give retirement planning the time it deserves.

 

The New Science Of Spending

In the good old days, retirement was simple.

You worked for 30 years with the same employer, received your gold watch for long service and then retired with a 2/3rds final salary pension – what could be more straight forward!

Nowadays, things are a little more complex.

We don’t tend to work for the same employer. Gone are the days of the final salary pension, leaving individuals to take more responsibility for their own retirement income. This retirement income will often come in many forms. Gone are the days of a single employer final salary pension that was completely automatic (no thought required).

Now we often work for 5 or more employers, collect various personal pension plans, company pensions, ISA’s and other savings vehicles for our retirement.

All of this needs far more management and input than has previously been the case. We no longer have the automated final salary pension where your retirement income was simply dictated by your final salary and length of service.

Now we have decisions on how much to pay in, what investment funds to choose, how much tax free cash to take and so on.

Now, the new auto-enrolment legislation has gone a small way to automating the pension system again, but most people acknowledge that this is just a sticking plaster and much more will need to be done to see the population at large enjoy a prosperous retirement.

The psychological shift

Perhaps the biggest shift (and one that people are yet to fully get their head around) is the psychological shift from an accumulation to a de-cumulation mindset when people retire.

Back in the days of fixed income final salary pensions, you didn’t really have to worry about this. You never accumulated a pot of money in the first place, you simply earned membership in the pension scheme which gave entitlement to an income in retirement.

At retirement that income turned on and you then had a nice monthly deposit into your bank account.

In the new world of pension freedoms, people will spend 20, 30, 40 or dare I say perhaps 50 years accumulating a pot of money. All of a sudden, when they retire, they then need to start de-cumulating (i.e. spending) that money.

The problem is that this is not an easy shift to make

When you have spent a lifetime saving money and building up your nest egg, it can be very distressing to see it start to fall in value.

Various studies have shown that in the investment markets, human beings feel the pain of loss about twice as strongly as the pleasure of gain.

I suspect that the same psychological forces are at work when we start to spend down our nest-egg – it hurts!

This often results in people holding back on their retirement spending plans because they simply don’t want to see the value of their pot fall. But this can lead to some real problems.

Occasionally we meet people who are living on a shoestring, despite having 7 (and sometimes 8) figure retirement portfolios and this is all because they don’t want to see the value of their precious nest egg go down.

But go down it must if we are to enjoy a great retirement – indeed, one must ask the question – if you wont spend the money in retirement, when exactly will you spend it?

 

 

 

Why Don’t We Ever Feel Wealthy?

In our seminars I often talk about the fact that no one really ‘feels’ wealthy.

This might strike you as odd, given that we spend our working day looking after people who are generally fairly well off by most standards.

It does seem however, that no matter how much money we have and how rich we appear to others, we don’t ever appear to feel wealthy in ourselves.

If I were to mention that this phenomenon occurs to people with £100,000 in wealth, then perhaps you could understand. Most would agree that £100,000, while a very nice sum indeed, is not enough to live a totally worry free financial life.

But we see this happening to people with over £1,000,000 in liquid wealth (that is excluding property values and other intangibles). Surely when you have £1 million in cold hard cash or investments you can call yourself wealthy?

Based on our experience, apparently not!

We regularly speak to people with £5 million or even £10 million in liquid cash and investments and yet they still do not feel wealthy in themselves.

Why should this be?

I don’t have any scientific evidence on this topic (perhaps this is a subject for my next dissertation?), but I have a few potential reasons why this could be:

  1. There is always someone richer. Whether you have £10 or £10 million, there is always someone richer who lives down the road or whom you know and associate with.

2. Some people don’t feel ‘worthy’. This is especially true when people have perhaps come from a less advantaged background and have made significant wealth with their own hands. In many cases, they don’t feel worthy of this new found wealth or perhaps they feel that they don’t deserve it.

3. I think the main reason though is down to mindset. Some people seem to be natural savers. They feel guilty about making large expenditures and always feel inclined to save as much as they can (even if they already have £10 million).

Other people, are natural spenders – they tend to spend money as they earn it, even if they do earn a lot.

This creates a bit of a problem because savers, generally, will continue to save and feel that they are not ‘allowed’ to spend, even when they have become incredibly wealthy.

Spenders on the other hand, tend not to become so wealthy in the first place.

So what is the solution? Well, as with most things, the middle ground is perhaps the best place to be.

It helps to have made a plan in advance about how much money you actually need to (insert goal here – retire early, but a boat etc). When you have defined the goal in advance you:

A – know when you have achieved the goal – you know when you can ‘stop’ and

B – generally feel less guilty about spending the accumulated money, if there was a specific goal or reason for saving it in the first place.

We call this ‘defining the finish line in advance’.

Much like in a race – you generally know the distance when you start and the type of pace you will need to run to win.

If there were no finish line already defined, how would you know when to stop? How would you know what training and preparation you needed to do?

The same is true with financial planning.

We find the clients who experience the greatest freedom around money are those who have a goal laid out in advance. This way, when they ‘make it’ they know that they have reached their finish line and can give themselves permission to stop (and go and spend some of that hard earned money).

 

 

 

 

The Folly Of Predicting The Markets

I think it is fair to say that the market reaction to Brexit took most people by surprise. While there were the inevitable few days of falls following the announcement of the result, the following stock market recovery across the globe was beyond the predictions of even the most respected market analysts and experts.

This single event is a good example of how completely futile it is to try to predict or guess the direction of stock market movements, now matter how sophisticated the models or assumptions being used.

In fact, when we look back in retrospect at predictions that have been made by analysts and financial experts, it turns out that you might just as well flip a coin to determine the future direction of travel, because these people are correct almost exactly 50% of the time.

These issues are particularly dangerous when thinking about investment planning for retirement.

I wrote last time about the significant shift in thinking required when investing during retirement. In the ‘new world’ of retirement planning, many people will choose a drawdown pension and keep their fund invested for life.

The danger here is that people get tempted to ‘trade’, rather than invest their retirement fund. I am aware of more than one case where people sold down all of the investments within their pension fund the day after the Brexit vote on the basis that the market was ‘definitely’ going to plummet.

Of course this did not transpire and these people have now missed out on the significant recovery, in which many global markets have grown by 10% or more. If we assume that many of us would be happy with an average growth rate of 5-6% per annum on our pension funds, this could mean that 2 years worth of growth has been foregone, just by being out of the market for a matter of weeks.

The irony here is that had we remained in the EU, I strongly suspect that the markets would have risen as well – a theoretical win-win situation. Of course, no-one knows what the markets might have done in the event of a remain vote, nor will we ever know.

Another good example of people trying to predict markets has been in the corporate and government bond space. Since 2009, I have heard countless people say that bonds are ‘definitely’ going to plummet or that they are ‘overpriced’. What has happened since 2009? Probably one of the strongest bond markets we have ever known, helped further still by the recent decision by the Bank of England to reduce interest rates.

The moral of the story here is that even when during retirement, investing should be seen as a long-term game. Given the inability of most people in retirement to top up their funds with earnings (once retired, for many people, what they have is what they have), it is easy to see the temptation to take rash actions to try to ‘protect’ the fund value.

If recent events are anything to go by however, quite the opposite can happen and much needed growth is missed due to being out of the market for just a few short weeks.

Income In Retirement – Consistency Is King

We looked last time at the importance of reviewing your investment strategy if you intend to use a ‘drawdown’ pension during retirement and leave your fund invested for the longer term.

For many the biggest risk of using a drawdown pension, rather than an annuity, is that the fund will run out during their lifetime. Of course, none of us can know for sure how long we will live and for most the tendency is to underestimate life expectancy.

One of the most important factors in determining how long your pension fund will last, is the consistency of the returns that are generated throughout the lifetime of the investment.

Many investors will be aware of the concept of ‘pound cost averaging’, which is where a regular payment into an investment is made and you ‘buy into the market’ at different points in time. The principal here is that it is actually positive to be buying investments when the market is lower, as you will be buying more shares for your money.

This point can be illustrated using a very simple example over a 3 month period, comparing a lump sum investment purchase of £30 vs a monthly payment of £10 per month.

 

Example 1 – Shares Purchased Up Front

Amount Invested Share Price Shares Purchased Final Value
Month 1 £30 £1.00 30
Month 2 N/A £0.50 N/A
Month 3 N/A £2.00 N/A £60

 

Example 2 – Shares Purchased Monthly

Amount Invested Share Price Shares Purchased Final Value
Month 1 £10 £1.00 10
Month 2 £10 £0.50 20
Month 3 £10 £2.00 5 £70

 

As you can see, in the second example, the fall in the share price in month 2 has been positive, as more shares where purchased, when have then gone up in value, meaning we have £70 at the end of the three months, rather than £60.

The issue with a drawdown pension is that the opposite of the above phenomenon is also true. This is where more shares have to be sold to provide the same level of income. So using our above example, if we wanted an income of £10 per month, 10 shares would need to be sold in month 1, 20 shares in month 2 and only 5 in month 3. The sale in month 2 of 20 shares would really damage the total investment over time.

As a result of the above, we favour investments that produce very consistent returns during retirement. It is far better to have a return of 6% per annum consistently every year, than an average of 6% per annum, but spread over a wide variety of different outcomes (-6% one year, +12% next year for example).

This is best illustrated with another example as follows:

 

Starting fund of £10,000, £500 withdrawal made at the end of each year.

 

Year 1 Year 2 Year 3 Year 4 Year 5
Consistent Return

(5% per annum)

£10,000 £10,000 £10,000 £10,000 £10,000
Variable Return

(average of 5%)

£8,500 £7,575 £7,984 £7,963 £9,214
Return In Variable Scenario -10% -5% +12% +6% +22%

 

As you can see, in both scenarios, the average return is 5% per annum, however in the variable return scenario, the first years are poor, meaning that we have a smaller fund to carry forward. Despite the large positive numbers in the latter years, the second fund has still not recovered to the same level 5 years later.

Of course the above is a simple example, however it does illustrate the importance of consistency when thinking about investing for retirement.

Lifestyle Funds That Put Your Lifestyle At Risk

People with their pension savings invested in lifestyle funds have suffered losses of 9% since February, says the Telegraph.
It criticises the insurance companies running these funds for not changing their methods since the pension reforms were introduced in April. The losses have occurred because the lifestyle funds progressively switch money from shares to fixed interest as you near retirement age and in recent months bond prices have dropped sharply. Experts say these lifestyle funds were designed for people intending to buy annuities at retirement, but many people will now use the pension reforms to keep their fund invested and make regular or occasional withdrawals, so a lifestyle approach will not be appropriate.

As you approach retirement, it is essential to review the investments within your pension fund and make sure they match the way you plan to use your fund in later years.

If you would like a professional view on your retirement investments, please contact us for a no-obligation Discovery Meeting, provided at our expense.

Beware Of Temptation

A majority of pensioners who were asked if they would sell their annuity – a reform the government is currently consulting on – said they would not sell, reported the Financial Times. Almost half said they thought they would get a poor deal. But almost one in five said they would sell either to pass on an inheritance or to fund healthcare costs in old age.

The sale of existing annuities is likely to be tricky and even if the government does go ahead with its proposals, many annuitants can only expect to get back a much smaller sum than they paid originally.

What needs to be remembered here, is that it is likely to be the same insurance companies who offer the annuities that will be offering to buy them back, and the cynic inside me says that they will want to take some profit along the way.

What Does The Conservative Election Victory Mean For You?

With the Conservatives surprising just about every pollster, media outlet and individual in the country with their majority election win, people may now start to wonder what might change from a financial planning point of view. Here we summarise some of the key Conservative manifesto pledges (a word of warning – these changes are yet to be implemented in law yet):

The conservatives have pledged to increase the tax free personal allowance to £12,500, while at the same time raising the higher rate tax threshold to £50,000.

Introduction of a new help-to-buy ISA, which will offer a bonus from the government for those who are saving for their first home.

The addition of a new Inheritance Tax allowance that can be used to pass on the family home. The proposal here is to give each individual a further £175,000 allowance to use for a family property, on top of the current £325,000 allowance.

Protecting various pensioner benefits such as the free bus pass and winter fuel payments.

Reduce tax relief on pensions for those earning over £150,000.

The key thing to remember here is that these are currently just manifesto pledges. These changes have not become law, nor has draft legislation been published. As with many things the devil will be in the detail so we will have to wait and see just how many of these proposals will become a reality.

Freedom Comes With a Health Warning

With all of the excitement and media comment surrounding the new pension freedoms, the 6th April itself seemed to pass without incident. While some providers have reported an increase in call volumes, it would appear that for the moment, there has not been a gold rush on the nations pension pots.

All of this new freedom and flexibility is fantastic for those who wish to use their pension pots to fund a lump sum purchase, a holiday or even a Lamborghini. However for those of us who still wish to generate an income for life with our pension funds, we have a tough choice to make. Do you purchase an annuity with the guarantee of an income for life, but with loss of your capital sum, or, do you opt for a drawdown pension and draw an income out of your invested lump sum.

While the latter option will be appealing to many, especially given the ability to pass on any unused funds to a beneficiary, it does come with a health warning.

You see the problem with this approach is that none us knows exactly how long we are going to live and therefore, how long this pot will need to last for. The main risk here is what we would call ‘sequence of return’ risk. That is to say, in what order do the returns on your fund occur. We all know that over the long term asset backed investments tend to out-perform cash, but they are volatile. The impact on your retirement of a 10% fall in your fund value during the first year will be very different to a 10% fall in year 10. It is very important to diversify and smooth the returns of the market as far as possible in order to protect your fund from sudden falls, especially in the early years.

This article from the Telegraph sums this up fairly well and is worth a read if you are considering taking a drawdown pension. While I am certainly in favour of the new flexibility rules, it is important that we consider all of the risks involved before taking the leap!

How To Blow Your Pension

You may have seen the Panorama programme on television on Monday night attempting to explain the new pension reforms. While the programme did highlight some of the potential pitfalls to be aware of, there were a couple of the sections that I felt were a little lacking:

  • At the beginning of the programme, the presenter looked at an average pension pot of around £32,000 and then proceeded to go on an imaginary shopping spree with the funds. The one problem was, he did not appear to account for the tax that would have been paid if you had taken this whole pension pot in full. Unfortunately, many people seem unaware that there is tax to pay on any pension withdrawal after the 25% tax free portion has been taken.
  • There was also a case study of a lady who had recently been ‘forced’ to purchase an annuity. The concept of a drawdown pension has now existed for over a decade and, since it’s introduction there has not been a ‘requirement’ to purchase an annuity. The sad truth is that many people did not understand the options available to them when making the once-in-a-lifetime decision about how to use their pension funds.

What the programme highlighted is the increased need to ensure that you are aware of all of the options available to you at retirement. A qualified Chartered Financial Planner can help you to do just that!