As our population ages and retirement periods get longer, how do we ensure that the savings and investments we accumulate ahead of stopping work – or stepping back – will fund the rest of our lives? Simon Prescott, Head of Wealth Planning at Nedbank Private Wealth, explains the concept of decumulation and why it’s an important development for people to understand.
People sign up as a new client at every life stage. But a lot of clients come to us in their 50s and 60s having saved and invested over the decades. They now feel that they have accumulated sufficient wealth to have a meaningful conversation about what’s next in life given the plethora of options typically open to them.
Then you have to break it to them that the hard part is actually ahead of them. Why? Because then you’re entering a phase of life called decumulation.
The difficult part, however, is that in retirement – or as you graduate towards that state – you become increasingly reliant on your investments, pensions and savings to completely fund your expenditure, or top up your earnings
It marks the stage when you can either retire, broaden your professional life into what’s called a portfolio career (where you take on multiple part-time roles, such as consultancy or non-executive directorships) or continue as before, albeit perhaps at a slightly slower pace than in the previous decades.
The difficult part, however, is that in retirement – or as you graduate towards that state – you become increasingly reliant on your investments, pensions and savings to completely fund your expenditure, or top up your earnings. As such, income ceases to be the money derived from business interests and/or employment and starts to be funded by those assets.
The difficulty of the descent
There is a nice analogy here with mountain climbing. Although I appreciate not everyone is equipping themselves for their staycation with Kendal Mint Cake and a rucksack, you don’t have to be a mountaineer to realise that the difficult part of a climb isn’t actually the ascent to the summit. More accidents happen on the way down. And it’s the same with your finances.
In becoming increasingly reliant on your investments, pensions and savings – sometimes for 40 years or more – you become exposed to a whole series of additional risks, beyond those categorised as investment risk.
So what are the risks?
While there are a number of retirement-related risks, it’s worth focusing on three:
Inflation risk
Even if you believe the current level is exaggerated by prices cut by the COVID-19 pandemic, relatively low levels of inflation, year in year out, could still slowly damage your long-term financesEven if you believe the current level is exaggerated by prices cut by the COVID-19 pandemic, relatively low levels of inflation, year in year out, could still slowly damage your long-term finances. There is also a high likelihood that the consumer price index number being published every month by the Office for National Statistics is not the same level as the price increases affecting your expenditure, which could be higher.
Top Tip
It often surprises me how little thought people put into the other side of the retirement equation. How you are going to utilise retirement savings and other assets to fund a desirable lifestyle right to the end is a multi-faceted question that can only be addressed with some sophisticated planning. Whatever stage of the retirement savings journey you are in, consulting a professional is likely to be a wise move and we can set up those conversations fast and free.
Lee Goggin
Co-Founder
Longevity risk
Although it is understood that people are generally living longer, those thoughts may not have extended to financial discussionsAlthough it is understood that people are generally living longer, those thoughts may not have extended to financial discussions. It is estimated that about 75% of the UK population live as part of a couple and given there is a one in four chance that at least one of the two will live to receive a telegram from the monarch. That could be you. Is it time to reassess your own expectations?
Sequencing risk
This is a relatively complex risk that is often confused by volatility, the measure of increases and falls in value of (in this instance) financial markets. Although that too is a risk for investors, sequencing – as its name suggests – relates to the order of your portfolio returns and kicks in when they are negative for multiple years at the early stages of your retirement and when you are taking withdrawals to live off.
The issue with sequencing risk is that, even if you step back and have enjoyed healthier returns over a much longer timeline in retirement, if the first few years were negative, you’re much more likely to find it difficult to recoup those losses.
The issue with sequencing risk is that, even if you step back and have enjoyed healthier returns over a much longer timeline in retirement, if the first few years were negative, you’re much more likely to find it difficult to recoup those losses
So how can wealth managers help?
First of all, not all wealth managers are equal. I appreciate you may take this statement from me with a pinch of salt, but the support you will need throughout your retirement should be broad as there are a number of aspects to balance.
You should already be taking advantage of the various options appropriate to you, such as ISAs and pensions, as well as the appropriate allowances, exemptions and reliefs. But it is also important you sell down your investments in a particular order
First, you should make sure that your wealth manager is able to proactively manage your affairs in a tax-efficient manner. You should already be taking advantage of the various options appropriate to you, such as ISAs and pensions, as well as the appropriate allowances, exemptions and reliefs. But it is also important you sell down your investments in a particular order. While individual circumstances may play a part, this typically means withdrawing funds from the least tax-efficient vehicle first, e.g. seeking to access ISAs ahead of pensions, given these are considered to be outside of the estate for inheritance tax purposes (as at the time of writing).
Active management is essential
You should also seek a firm that actively manages your portfolio. Although this could allow for some, or all, of your underlying investments to be passively managed, we believe it important to regularly review and manage the asset allocation. This is vital as risks vary over time – this applies both to market risk and risks specific to you. An active asset allocation may also help you benefit from underlying aspects of individual asset classes as and when, e.g. investment trusts provide liquidity due to their closed ended nature meaning that the funds are unlikely to be gated, which we saw with, for example, some open ended property funds in 2020.
The skill set in actively managing your asset allocation supports another aspect of decumulation – rebalancing. This sees your investments straddle two levels of risk, with your manager moving funds periodically from the higher risk portfolio to the one with a lower risk profile. The more cautious portfolio is used for shorter to medium-term cashflow needs, protecting more of your capital from large market swings due to the types of investments used, which also helps mitigate sequencing risk. The second portfolio is managed at a higher level of risk, which would usually see you invested in assets such as equities and property, which can help mitigate inflation and longevity risks. Together the risk level should be the same as any you would be exposed to today following an informed risk profiling approach. Managed as a single portfolio, however, your wealth may erode due to the competing needs longevity risk and sequencing risk require.
The second portfolio is managed at a higher level of risk, which would usually see you invested in assets such as equities and property, which can help mitigate inflation and longevity risks
Last but not least, you should also find a manager in whom you can be confident and who will still be managing your wealth with the same due care and attention in the decades to come as they do today. After all, it is only much later down your timeline that you will really be able to assess whether the support provided has led to a life well lived.
