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Retirement & You

By Philip Kozloff, Kozloff Consulting, philipkozloff@mindspring.com

Looking forward to a successful retirement depends on knowing where you are and having some idea of your requirements when you get there. Bridging the gap between “here” and “there” is a manageable task if the end points are understood.

No investment strategy is complete without a discussion of risk and risk appetite, and financial planning for retirement is no different. Personal risk appetite over the course of one’s life might resemble an upside-down bell curve. The highest risk tolerance should be at both ends of the natural life cycle, extended to cover dependants.

A working youthful investor can replace investment losses with mid-career earnings. Arguably, an investor at the end of his life is no longer providing for his own living needs but those of his heirs. This may be whether they need it or not. Certainly, surviving spouses need to be provided for. That may not be the case with children who are embarked on their own earning careers. Don’t forget the over-50 adage: “If you don’t fly First Class, your children will.”

Lowest risk tolerance should be in the middle to late-middle zones – somewhat before, and well into, retirement years when there won’t be any salary to replace sour investments. Therefore, a sound retirement investment strategy should assure that fully loaded living expenses and taxes, net of pension flows, are covered by a conservative investment yield expectation. With a little luck, a well-managed portfolio can outperform your expectations. But avoid reaching for higher yields on personal investments that lure you into greater risks.

Modern portfolio theory holds that risk is reduced through diversification. This applies to family portfolios as well as to business. The first step to understanding your personal portfolio is to inventory all assets and liabilities. But the approach is different from putting together a loan application, for instance. You want to develop a picture of how your assets are proportioned, and what their income-generation capacities are, rather than coming up with an impressively large total number.

Some asset classes have more flexibility than others. For instance, property, or real estate, has more liquidity in rising markets than it does in declining scenarios. But your need to have permanent shelter conflicts with the ability to easily liquidate one’s primary residence in search of liquidity. Investment real estate, like some business investments, can be even more difficult if owned in partnership with other investors whose goals and needs may not be the same as your own.

Other forms of personal wealth may be reassuring in the long term, but bear significant penalties for rapid liquidation. Expensive jewellery, art, antiques, and old car collections may impress the neighbours, but the buy-sell spreads can be enormous. Even where impressive notional market value gains in these asset types are recorded, the reselling process can be time-consuming and expensive.

If you have other non-financial assets, such as a string of polo ponies or an ocean-going yacht, these should be noted in your personal inventory. Finally, other items of personal property such as cars and furniture should be recorded in broad round numbers with the understanding that they tend to be depreciating assets and are rarely material to a successful retirement strategy.

Your financial interests require the most disciplined and rigorous inventorying. This will be the basis for communicating with financial advisors, if any, so that they can best understand your needs and deal with the entirety of your portfolio.

The elements of a financial assets inventory should include cash, near-cash, insurance policies, pension fund investments, stocks and bonds. This may involve sorting through your personal files to dredge up dormant bank accounts or share certificates that your Aunt Tilly left you in 1979. Present values, if not obvious from the statements, might be available from the issuer or from your broker.

Your inventory should be at a summary level and should be refreshed quarterly. Details, such as individual share holdings, need not be included. Working from brokers’ statements or your own separate worksheets, you should list the major category totals. This could be long-term bonds, large corporate equities, small corporate equities, or international shares. Mutual or retirement funds should be categorised according to their investment styles. Fund prospectuses or rating services, such as Morningstar, routinely report these values. Future columns will give you some ideas on how to evaluate your financial assets holdings and strategies.

Valuable non-financial assets can be important, too, although they present different sets of problems for financial planning. For instance, let’s think about your primary residence. For many of us, this is the largest single concentration of investment for most of our working lives. Escalating house values in many markets has increased the significance of that asset class to many prospective retirees’ portfolios. Paradoxically, there are problems of appreciating-value houses that become magnified as retirement approaches.

First, there may be a hefty mortgage underlying the valuation bloom. Whilst some lenders may be happy extending 30-year loans to 50-year-old people, it may not be in the best interests of the borrower to see the mortgage to full maturity. Mortgage lenders typically are happy to encourage borrowers to dedicate 25 to 35% of salaries to service the debt.

Substantial mortgage payments may have been easily digested under your salaried cash flow. But pensions are usually a fraction of working salaries and, therefore, continuation of the same mortgage payment stream could gobble up all of one’s pension payments. This may give the prospective pensioner a set of difficult choices. If he or she wants to continue living in the property, early retirement of the mortgage may be called for.

Although any debt, mortgages included, can leverage investment yields, it has the effect of increasing risk. This is more appropriate well in advance of retirement when salary-based cash flow is most robust. You may want to develop a plan for systematic early partial mortgage pre-payments (if allowed, which is not always the case) or to set aside an invested pool of funds to make a full mortgage payoff at the right time.

If the value of the house has increased to such an extent that it becomes an overarching element of one’s financial profile, it may be time to release that hidden reserve for more active redeployment.

Of course, you have to live somewhere. Selling out of your working-life house and buying an inexpensive rural cottage in France may have economic attractions, but could be a disaster if finances are your only motivation. Chances are that similar houses or flats in your neighbourhood have enjoyed similar escalation in values. So, a release of house equity is possible only if you are prepared to change the nature of your housing either in terms of location, size or amenities.

This column cannot help you make these deeply personal choices. We will restrict ourselves to the financial side of your portfolio in future issues. The approach will be to help you format the decisions; what you do will be left entirely up to you.

Profit & Loss

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