{"id":14216,"date":"2019-01-16T17:11:29","date_gmt":"2019-01-16T07:11:29","guid":{"rendered":"https:\/\/www.prosolution.com.au\/?p=14216"},"modified":"2019-01-16T17:27:38","modified_gmt":"2019-01-16T07:27:38","slug":"fund-retirement-capital-growth-investment-assets","status":"publish","type":"post","link":"https:\/\/wealthcoach.com.au\/stage\/fund-retirement-capital-growth-investment-assets\/","title":{"rendered":"Can you fund retirement from capital growth?"},"content":{"rendered":"\n
\"investment<\/figure>\n\n\n\n

When working out a retirement strategy, often people try to\nwork out the value of investments they will need by multiplying the amount of\nannual retirement income they will need by a nominal interest rate. For\nexample, if you want $100,000 p.a. in retirement and you think you can earn an\nincome rate of say 3% p.a., you\u2019ll need $3.4 million of net investment assets. The\nmore aggressive you are with your interest rate assumption, the fewer assets\nyou need to meet your goal. The reverse is also true. <\/p>\n\n\n\n

Beware, there are a couple of pitfalls with this approach. <\/p>\n\n\n\n

It results in a lazy asset allocation <\/h3>\n\n\n\n

If all of your investment assets are invested in cash or\nfixed interest investments (such as government and corporate bonds) in order to\ngenerate a stable income, you have little protection from inflation. This is\nbecause these investments do not provide any capital growth. All their return\nis provided in the form of income and your capital stays the same \u2013 think term\ndeposit.  <\/p>\n\n\n\n

This means that over time, your assets will be worth less\nand less in real<\/em> terms \u2013 because of\ninflation, your purchasing power is reduced. For example, $1 million today will\nbe equivalent to $477,000 in 30 years\u2019 time assuming the inflation rate\naverages 2.5% p.a. over that period. <\/p>\n\n\n\n

People are living longer. Medical technology is improving at\nan increasing rate. Therefore, we must consider the likelihood of living to age\n100 and beyond. To ensure you don\u2019t run out of money, you must ensure you\ninvest in assets that provide some capital growth so that your money at least\nkeeps up with inflation and hopefully increases over time. <\/p>\n\n\n\n

You must account for taxes<\/h3>\n\n\n\n

Of course, you must account for any taxation liabilities. If\nall your money is inside super (and your balance is less than $1.6 million),\nthen no tax will apply if you draw a pension. However, if you have assets\noutside of super, you will need to account for any income tax consequences. The\ngood news however is that an individual can earn approximately $20,500 per year\nbefore they need to pay any tax. Therefore, hopefully you can share any\npersonal income between you and your spouse to minimise any taxation\nliabilities. My point here is you must think carefully about ownership\nstructures i.e. where your investments are held. Super is excellent, but you\ndon\u2019t want to put all your eggs in one basket. Putting all investment assets in\none person\u2019s name also typically isn\u2019t very wise in the long run.  <\/p>\n\n\n\n

Markets will go up and down <\/h3>\n\n\n\n

The role of asset allocation (i.e. the methodology used to\nspread your money across various asset classes) is to smooth returns and\nminimises losses. That is, some asset classes are negatively correlated which\nmeans when one asset class generates high returns, the other will likely\ngenerate low or negative returns. However, if you invest in both asset classes\nin the right proportions, you will achieve better investment outcomes at a\nportfolio level. This (i.e. asset allocation) is the most important decision a\nprofessional advisor can help you with. Its an investor\u2019s most important\ndecision. Because investors cannot control markets or returns. But they can\ncontrol where and how they invest their monies. <\/p>\n\n\n\n

Therefore, by putting all your money in cash and fixed\nincome assets, you risk missing out on a lot of returns. Take the last decade\nfor example. Government bond returns have been historically very low \u2013 sub 3%\np.a. Whereas international equity markets have provided a total return of just\nunder 10% p.a. over this period of time. This demonstrates the perils of\nputting all your money in one asset class. <\/p>\n\n\n\n

Sometime in the future, this will probably reverse. Equity\nmarkets will perform poorly, and bonds will perform well. Therefore, we must\ninvest in a way that positions our money to perform well regardless of how\nindividual markets behave. <\/p>\n\n\n\n

Maybe interest rates will be lower for longer? <\/h3>\n\n\n\n

There as been a lot of commentary<\/a> since the GFC that perhaps interest rates will be a lot lower than they were in the two to three decades before 2008. Quantitative easing and loose monetary policy are two reasons that are cited for adopting this view. I am always cautious when anyone forms the view that history will not repeat itself \u2013 because it invariably does. Therefore, I do leave room for the possibility that interest rates (and more specifically bond returns) will one day rise above 3% p.a. However, equally, I leave plenty of room for the possibility that rates will be persistently low for a longer period of time. If this is true, then putting all your money in cash and fixed interest securities will be financially unproductive. <\/p>\n\n\n\n

You risk overestimating the amount you really need<\/h3>\n\n\n\n

If you assume that all retirement living expenses need to be\nfunded from investment income, you must therefore assume all your monies will\nbe invested in income-style assets (cash and fixed interest). As such, you will\nneed to be relatively conservative with your interest rate earning assumption,\nespecially in the current environment (e.g. current term deposit rates are\ncirca 3% or less). This will mean that you will need more wealth in order to\nachieve your goal. <\/p>\n\n\n\n

However, if you assume that you will have a more diversified\nasset allocation e.g. a mixture of Australian and international shares and\nbonds, it is reasonable to assume a higher overall portfolio return (see more\nbelow). This will then mean you need less wealth to fund retirement than what\nyou might have originally thought. <\/p>\n\n\n\n

So, how do you fund retirement then?<\/h3>\n\n\n\n

Most people will not be able to fund retirement purely just\nfrom investment income \u2013 they will need a combination of income and capital\ngrowth \u2013 for the reasons discussed above. <\/p>\n\n\n\n

This is achieved through developing an appropriate asset\nallocation target and then a long-term strategy to achieve that target by the\ntime you reach retirement age. For example, an investor might aim to achieve\nthe following asset allocation by retirement age:  <\/p>\n\n\n\n