With pension freedoms arriving next month, today’s retirees have serious and complex decisions to make about their financial futures, over which they now have unprecedented control. Investors who may once have bought an annuity will now need to carefully manage risk to prevent against the potential loss of future wealth, while accessing competitive returns to grow their assets to sustain their lifestyles through retirement. Traditional investment options will need to be rethought.
Instead of purchasing annuities, we predict that many investors will be well-served by multi-asset income funds that are easy to understand, accessible, and lack complex and expensive guarantees. These funds offer the potential to build and preserve wealth, beat inflation, and reduce the risk of outliving one’s assets. These strategies are able to provide income, along with the growth and diversification that is prudent for income investors.
The reality is that outliving your income stream has become a significant risk. If you’re part of a married couple aged 65 today, there is a 66 per cent chance that one of you will live to be at least 90 years old. Juxtapose this with the expected retirement shortfall and the future starts to look grim.
For most people, thinking about retirement planning is like scrutinising a giant flow chart of myriad factors. There are some over which the individual has total control, such as their rate of saving and spending, or the risk they take in their portfolio. There are other factors over which the individual has some degree of control, such as the duration and earnings level of their employment and their own longevity. Finally, there are a range of factors over which individuals have no control, such as market returns. As such, knowing that a wide range of variables can determine financial security in retirement, understanding retirement spending, and planning accordingly is critical.
This leads us to two potential models for structuring a sustainable retirement income stream. The first involves a so-called bucket method. The individual’s assets are arranged into three buckets according to time horizon, with the near-term portfolio (regularly tapped for spending) invested in cash and cash alternatives. The medium-term portfolio can be invested in slightly higher-yielding assets such as dividend-paying equities, while the third bucket in the portfolio can be reserved for riskier, higher-return strategies or for longer-dated savings instruments. Such a model can help investors grow wealth over time, while maintaining spending to support their lifestyle. But at best it is an inexact rule of thumb.
A second model, which we would tend to favour, involves a triangle. Starting from the base of the triangle, you move up the spectrum of risk and return. The bottom and largest portion of the triangle comprises needs – the basic assets that you need to cover regular expenses. The income sources at the bottom of the triangle tend to come from your state or defined contribution pensions, Isas, short-term bonds or cash savings. We think of the middle of the triangle as your wants – what you desire from your lifestyle in retirement. Sources of income in the middle of the triangle tend to come from investments in equities or fixed income. As we reach the top of the triangle, there are the legacy considerations, where an investor might be considering assets to leave to his or her heirs. This income can be sourced from more high risk investments or structured in trusts.
Structuring a suitable retirement income stream is different for everyone. What is the same for all is the desperate need to start saving for retirement earlier and to do it more consistently. The numbers speak for themselves on the power of compounding over time, and they are too important to ignore.
Diversification is also vital, as a balanced portfolio is better-placed to generate returns in all types of market environments. Over the long term, a portfolio that is diversified across equities and bonds can help to dampen volatility, providing a smoother ride.
No matter how individuals ultimately choose to tackle the retirement income question, however, we think many will be well-served by multi-asset income funds. Multi-asset diversifies risk, making income more sustainable, without the costly guarantees involved with annuity products. They are flexible and tend to be tax efficient. Importantly, they are also a cost effective solution.
Diversification is an important benefit of these strategies. Our multi-asset solution (JPM Multi-Asset Income Fund) builds in diversification on a global scale, incorporating over 1,500 securities across 50 countries and 10 distinct strategies, while maintaining a risk profile in line with a traditional balanced risk strategy (60 per cent equities, 40 per cent bonds). Multi-asset class solutions focused on long-term capital growth and sustainable regular income will be well-placed to serve the needs of clients no longer in the market for annuities.
Jasper Berens is head of UK funds at JP Morgan Asset Management.