What to do with your investments when you retire



NAV TL;DR

If you don’t have time to read through the whole article, you can check out our short version below:

Invest early to build up your nest egg.

People are living longer. Hence, your nest egg needs to continue working for you, earning returns that you can live on, even in your retirement years.

The income approach entails living on your portfolio returns—including dividends paid from stocks, bond coupons, and interest on cash—without touching the principal.

Retirement is an expensive affair – inflation pushes up costs, medical expenses will grow exponentially, and Singaporeans now have the longest life span in the world.

Unless you’re a very high-income earner and you can save a lot, money in a bank account is unlikely to provide well for you.

It is therefore vital to invest early to build up your nest egg. It is established wisdom but worth repeating: You need to invest to get the sort of returns that can put you in a better financial position in your retirement years.

Traditional financial advice was to reduce risk as you age. The logic was that over the long term, stock prices mean-revert—return to their average levels—enabling younger investors to ride out the ups and downs of market cycles, eventually towards new highs. However, when you are closer to retirement, you have less time to recover from cyclical downturns, hence the need to preserve capital.

So, the traditional financial advice has been to shift from a growth portfolio (one with a relatively high percentage in riskier assets such as stocks) during your prime earning years towards a preservation portfolio (one with a high percentage of lower risk assets such as bonds and cash).

While there is nothing wrong with the logic of de-risking as you age, what has changed is that people are living longer now. In Singapore, people can expect, on average, to live more than 20 years past the current retirement age.

That’s a long time to live on your savings. Instead of spending down your accumulated wealth, your nest egg needs to continue working for you, earning returns that you can live off, even as you age. So, the speed and the way people de-risk their portfolios may need to be adjusted to cope with the many more years lived in retirement.

A conservative approach is to live o¬ only the returns generated by your portfolio, never touching the principal. That is, you would only spend the dividends paid from the stocks, coupon payments from the bonds, and interest from the cash held in your portfolio, never touching the capital that generates this income.

This entails having built a diversified portfolio that incorporate dividend-paying investments, such as bonds, dividend stocks, and real estate investment trusts (REITs).

Although the purchasing power of that portfolio will be eroded by inflation, the risk of running out of assets and funds is low. Indeed, retirees should still have a portfolio of assets to bequeath to loved ones.

One consideration is you need to have sufficient assets to generate enough fixed income to sustain your desired retirement lifestyle. Hence, unless you have a large enough portfolio, you may inevitably have to dip into your original capital.

A second consideration is that the income that you get may fluctuate, depending on market and economic conditions. For instance, if a company you invest in decides to lower its dividend payout in a particular quarter, your income may fall accordingly. In addition, there are also periods—such as the ones we are currently in—when bond yields and interest rates are too low to provide sustainable income.

The third consideration is the spending power of the income generated will also be eroded by inflation. And as you do not reinvest your dividends or coupons, you miss the opportunity to further compound your portfolio returns.

In summary, this strategy is more viable if you are a very asset-rich retiree. If this approach appeals to you, start investing early to give time and compounding the runway they need to grow your nest egg.

Learn more about other approaches to managing your investments into retirement, such as the 4% rule and the floor and ceiling approach.

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