The “retirement spending smile”

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Retirement spending shown to decrease with age

We have written a lot about the pattern of retirement spending, with “Will spending remain constant in retirement?”, from 2013, and “How much do I need to retire, revisited?”, of only three months ago, being particularly relevant. The underlying theme of these articles is that we don’t believe our “Rule of 25”, the suggestion that you need investment wealth of at least 25 times your expected annual retirement spending to be highly confident of financing a 30 year retirement, is conservative or an unrealistic “rule of thumb response” to the “How much do I need to retire” question.

However, a recent article in “Forbes” magazine, titled “What is the ‘Retirement Spending Smile’?”, by Professor Wade Pfau, a prominent US academic specialising in the financial planning field, provides another potential challenge to the robustness of the “Rule of 25”. It examines US research on retirement spending, by David Blanchett [1], that suggests spending tends to decrease both at and during retirement at a real rate of about 1% p.a.

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Will share returns remain low?


Share and cash investment returns are unexciting

It feels like the Australian share market has been going up and down in about the same spot for the past six or seven years. Many are becoming disillusioned with shares as an investment class and are looking to “juice returns” with the various hybrid structures and private equity “opportunities” on offer to take advantage of the discontent.

Cash, in the form of term deposits, has also lost its lustre, with yields at record lows. It’s not surprising that in this environment the perennial favourite, direct investment into residential property, has become even more popular. The house price rises experienced over the past three or four years, particularly in Sydney and Melbourne, make the share market appear a pretty dull alternative.

This article examines some of the historical facts that underpin current feelings. While we don’t know what will happen in the future, the past suggests that current investment returns are not inconsistent with what investment theory would expect and may not be a good guide to future investment returns.

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How much do I need to retire, revisited?


The “Rule of 25” sets a daunting target, for many

When we talk to prospective clients who are at or close to retirement, one of their inevitable questions is “Have I saved enough to retire?”. We explain that while we need to understand their situation in greater detail, our rule of thumb is that they should aim for at least 25 years of expected annual spending i.e. our “Rule of 25”.

So, if they expect to spend $100,000 p.a. in retirement, a reasonable guide is that they need more than $2.5 million in net investment wealth, assuming they wish to stay in their current home and have no other lifestyle assets or expected inheritances to draw on.

Unfortunately, too often, our prospective client has saved nowhere near this amount, with little prospect of doing so between now and retirement. Typically, they may have saved about 15-16 years of their expected annual spending i.e. $1.5 – $1.6 million in the above example.

It isn’t unusual for them to comment that that they are sure that many of their friends are far less prepared, financially, for retirement than they are and to ask how will such people cope. They also ask or, we suspect, think, are we too conservative?

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Should parents assist adult children to buy their first home?


Our Prime Minister and RBA Governor suggest parental support is required

In November 2014, we published a Blog article titled “How do you give financial help to your adult children?”. Its focus was to match any assistance provided with the objective of developing children’s financial maturity. The views expressed were not influenced by what was actually happening at the time i.e. they were meant to be as timeless as possible.

However, since then, housing prices have continued to rise, particularly in Sydney. Young adults are finding it increasingly difficult to purchase a first home to meet their current living requirements. For most, housing that is also consistent with raising a future desired family is out of the question.

This has prompted a number of commentators, including both the Prime Minister, Malcolm Turnbull, and the retiring Governor of the Reserve Bank, Glenn Stevens, to suggest that the only way many young adults will be able to purchase their first home is with significant parental support i.e. the “Bank of Mum and Dad”. There is often an inference that “good parents” should provide such support.

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The power of compounding and deferred gratification

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“Compound interest is the eighth wonder of the world”

The following quotation is often, most likely incorrectly, attributed to Albert Einstein:

“Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t …pays it.”

“Compound interest” refers to the practice of continually reinvesting earnings received on investments over long periods of time (e.g. 40 years), as a mechanism to accumulate wealth. Regardless of who was responsible for the hyperbolic statement above, it’s a reality that the considerable power of compounding is not well understood by most and, even if understood, requires an ability to defer gratification that seems to be beyond many.

Like the achievement of a lot of generally desired things in life (e.g. becoming physically fit, losing weight, competence at a selected sport, hobby or musical instrument), accumulating wealth through compounding takes long term commitment and discipline. Early in the process, there may be little apparent reward for considerable sacrifice, making it difficult to resist the temptation to spend now rather than save and/or to think that there are few consequences for deferral of saving to later in life.

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Is superannuation’s wealth accumulation role in jeopardy

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The 2016-17 Budget proposed major changes to superannuation

We have previously discussed our “Personal Financial Dashboard” that graphically captures where a client is on the road to their version of financial independence. A key dashboard measure is the so-called Tax Effectiveness Ratio (“TER”), calculated as the ratio of superannuation holdings to total Projected Lifetime Investment Wealth.

Because of the tax effectiveness of the superannuation environment, we encourage clients to target a TER of at least 75% to be achieved by retirement. For some high income/high net worth clients or for clients who have delayed maximising super contributions, increasingly restrictive contribution caps may make this an impossibility.

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The Reverse Mortgage in action

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Two specific applications of the reverse mortgage are examined …

In last month’s article, “The Reverse Mortgage: an underutilised retirement planning tool?” we explained that a reverse mortgage is a potential solution for retirees who both wish to stay in the family home indefinitely and continue to enjoy a lifestyle beyond what their investment wealth is able to support.

Without access to a reverse mortgage, such retirees would be forced to either downsize to free up capital to live on and/or revise their lifestyle expectations downwards. Neither option may be particularly palatable.

In this article, we examine how a reverse mortgage would work in such a situation. We refer to it as the “Maintain lifestyle” scenario. We also discuss a scenario called “Bring forward inheritance” in which a reverse mortgage is utilised to provide assistance to adult children while retired/near retired parents are alive, rather than delay the children’s access to proceeds of the family home until the parents’ death.

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The Reverse Mortgage: an underutilised retirement planning tool?

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Australians’ wealth concentrated in the family home …

We have long been of the view that Australians, in general, have too much wealth tied up in the family home. For those at or near retirement, a corollary is that they often have insufficient investment assets to support their desired lifestyle for an extended period without needing to downsize or being prepared to survive beyond some unknown future time on the age pension.

This unsatisfactory situation is revealed by a measure of financial independence that we call the “Investment Wealth Ratio” (“IWR”). As a “rule of thumb”, we suggest that at retirement at least 55% of total wealth should be held in investment assets and, correspondingly, less than 45% in the family home and other lifestyle assets. But most Australian households either approaching or in retirement have an IWR significantly less than 55%.

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Housing: both unaffordable and expensive?

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Spending on housing has risen almost unabated since 1960 …

We have written previously about current housing affordability for young adult Australians (see “Are Australian house prices too high?” and “Housing and home loan affordability … again”). Our focus was the perceived inconsistency for those in their mid twenties to mid thirties of meeting both the current cost of housing (for purchase or rent) and accumulating sufficient investment wealth for financial independence by their mid-sixties.

It is sometimes suggested that a potential resolution to this “inconsistency” is a reduction in spending on other goods and services. The chart below shows how Australian households have allocated their disposable income over the period from June 1960 to June 2015:

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Diversification v Concentration: A tortoise and hare story

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Concentrate your investments to make and lose a lot of money

The following recent Twitter exchange was the catalyst for this article:

The initial tweet above is a quote from Jim Rogers, a well known US investment commentator, who believes he can reliably pick investment winners and time investment markets, despite robust academic research suggesting such skills are both incredibly rare and difficult to identify. However, his view that if you want to make a lot of money you should avoid diversification (i.e. spreading your investments as broadly as you cost effectively can) is undoubtedly correct.

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