SPONSORED CONTENT: Income matters as much in retirement as it does in business

Working less to pay for more life: a 1930s Australian retired at 65 years old, but was expected to live to only 63.  Since then the ratio of years worked to years retired has increased dramatically.

In the 1930s, the average Australian worked from 16 to 65,  or for 49 years, but life expectancy was only 63 years.  That is, the average person could spend 100% of their income as they earned it, not needing to worry about funding their retirement years. 

By the 1970s, we started work a bit later at 20 and retired at 62, with a life expectancy of 71.  That is, we worked 42 years and had an average of nine years in retirement.  Each year of work needed to additionally pay for three months in retirement.    

Now we work from 23 on average, and retire at 58, with life expectancy of 82.  We work for 35 years and on average are retired for 24 years.  Each year of work now needs to additionally pay for eight months in retirement. 

Managing your retirement is no different to managing a business – the golden rule is don't run out of money.  Assuming you are already retired, you need to earn more income without blowing up the business (your capital), and try to cut costs without killing off the business (your lifestyle!). 

The difference is that in business you can sometimes raise more money.  Once you retire, you have a finite amount of wealth to fund your retirement years, so the risks of getting it wrong are higher.  

“The asset class that most investors consider the ‘safest' – cash – is actually extremely risky” – Warren Buffett, Berkshire Hathaway AGM

Because of the dramatic consequences of getting it wrong, retirees should increase income to a point that helps you fund your lifestyle but no further. 

Similarly, like in business, earning too little income will result in “going out of business”, in this case running out of money before you can afford to. 

In today's environment where cash deposit rates are at historic lows, and not expected to rise in the foreseeable future, allocating too much to cash is actually one of the riskiest investment strategies. 

Warren Buffett made this point: “The asset class that most investors consider the “safest”—cash—is actually extremely risky.”  This ‘zero-risk' strategy will steadily erode the value of the nest egg over the retiree's life even with very modest withdrawals.

On the other hand, an equity-only portfolio has high expected returns, but comes with more and more short-term volatility as the world recovers from the GFC. 

Given this conflict between the need for safety and the need for growth, it's no wonder retirees around the world use bonds to increase their income.  Bonds are the middle ground between cash and shares – they offer greater security than equities, while offering more income than cash.

Boosting your retirement income with fixed income

Fixed income involves less capital risk than shares by its very nature.  Because bond interest must be paid by companies before any dividends are paid, they are by definition less risky than the shares of that same company.

The table below shows 10 examples of well known Australian companies with their shares on the ASX and with bonds available to SMSFs.  The table shows that whether its equities or bonds that offer the higher yield varies company by company.  Security of capital however is consistently better for bonds than equities, for the reasons above.

The great advantage of the SMSF investor is that they are not constrained by asset class or other artificial boundaries.  They can choose to invest in a company in a way that suits their view of that company – where they are bullish on share price growth prospects, they can invest in the shares; and where they just want income, they can invest in the bonds.