To protect my retirement income from another financial crisis.
Don't tell me I need to do that! Let's hope not. But while some analysts are predicting better times in 2012, the financial world is still a highly uncertain place. If you're depending on your savings to pay the bills and provide money to live on, it could be better to play it safe.
So what can I do?
The manager for financial advice and education at NGS Super, Andrew Dunkerley, says the "bucket" or "drawdown" strategy for retirees still has much to recommend it. This is a relatively simple concept. You put aside a certain amount of "safe money" into investments such as cash and/or fixed interest so that if the worst happens and markets fall again, you don't have to sell investments at a loss to fund your income. You can live off your safe investments and give the growth assets time to recover.
How much should I set aside?
Before the global financial crisis, setting aside enough money to fund two years of income payments was a widely used rule of thumb. But Dunkerley says the severity of the GFC led to a rethink. Now five years to seven years is viewed as prudent. He says while most bear markets have historically ended within two years, more severe market falls can take longer to return to square one. The Australian sharemarket, for example, took almost six years to surpass its September 1987 peak after the October 1987 crash. And after dropping almost 19 per cent in 1932, the US Dow Jones index didn't regain its September 1929 peak until November 1954. Dunkerley says that while it had made up about half the loss by 1937, it moved up, down and sideways before resuming a new bull run in 1949. There's probably not much you could do to prepare your retirement portfolio for a disaster of this scale but he says having five to seven years of income in defensive assets should help you through most downturns.
How much of my portfolio should I set aside?
Dunkerley says that will depend on your investments how much income you need to live on whether you're receiving any age pension and your risk tolerance. Because growth assets have historically provided better returns, he advises "tilting" your portfolio to more defensive assets rather than keeping all your savings in cash - particularly if you've already lost money during the GFC. While it might be tempting to run to cash, he says the risk is it will take longer to recover the money you've already lost.
What happens when I use up all my safe money?
Dunkerley says this is not a set-and-forget strategy. You will need to review it regularly and re-balance your investments to replenish the "safe" bucket by taking profits on your growth investments. He says if you don't re-balance regularly you could find the proportion of your money invested in shares increases dramatically during a bull market. And while that might feel good at the time, you'll lose much more than you bargained for when a correction comes.
"The greatest risk with this strategy is depleting your defensive assets as the market bottoms," he says. He says your allocation to safe investments may also need changing as you get older, or your income needs change.
Is setting up this type of strategy complicated? Does it mean I need several pension products?
Dunkerley says you can usually do it through a single account-based pension. The only catch is to choose a product that allows you to select which investment option you're drawing down your income from avoid products that require you to draw down a proportion from each investment option. Dunkerley says another option is to invest some of your savings in annuities that provide a guaranteed income for life or a fixed period. A lifetime annuity has the added advantage of ensuring you won't run out of money before you die - but it means locking your money away. Account-based pensions, he says, offer more flexibility.