Why decumulation matters

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As longevity lengthens and time as a retiree gets longer, how do we make sure the savings and investments we accumulate ahead of retirement can fund the rest of our lives?

Sponsored content by Cameron Walker, head of private banking for Jersey at Nedbank Private Wealth, explains what decumulation is and why it is an important approach to understand

PEOPLE become wealth management clients at any age, but lots are in their 50s and 60s. Having saved and invested for decades, they believe they have accumulated sufficient wealth for the next stage in life. This is good as it’s a complex phase of life known as decumulation.

It is a time for you to retire, transition into a portfolio career of part-time roles (such as consultancy or non-executive directorships) or continue as before, although perhaps at a slower pace.

It is also, however, when you become reliant on your investments, pensions and savings to fund your life, either completely or by topping up earnings.

One easy analogy which we find helps is that of climbing. I appreciate that not everyone is a fan – which is good given Jersey’s geography – but you don’t have to be a mountaineer to recognise that the most difficult part of a climb isn’t the ascent. Indeed, 75% of accidents happen on the way down. Your finances could face similar difficulties.

By becoming reliant on your savings and investments – sometimes for 40 years or more – you become exposed to additional risks.

What are the risks?

While there is always a risk beyond investment risk, we focus on three:

1. Inflation risk

As inflation has been relatively low for approximately 20 years, many people underestimate the risk posed to their finances. The latest Jersey retail price index reading of 2.9% is not particularly high, but it is probably higher than some of your returns. This means you are losing money in real terms and even lower levels may still impact your long-term finances. There is also the likelihood that the retail price index number published every quarter by Statistics Jersey is not flagging the price increases affecting your expenses, which could be higher.

2. Longevity risk

While we are all generally living for longer, the benefits of more time come with the real risk of outliving your wealth.

And, although we understand that people are generally living longer, the view may not have led to financial discussions. Not only does the increased time on Earth mean your savings need to last longer, but there is also an increased risk of ill health as you age.

3. Sequence risk

A comparatively complex risk, sequence risk is often confused with market volatility. Although that is also a risk, sequence risk – as its name suggests – relates to the order of portfolio returns, kicking in when they are negative for a number of years at the start of retirement and when you need to withdraw capital.

Sequence risk may apply even if you enjoy healthier returns over most of your retirement. If the first few years were negative, it is often difficult to recoup those losses.

Active investment management is essential

Given these risks, you should seek a firm that actively reviews and manages your asset allocation, even if some, or all, of your underlying investments are passive. This is critical as risks change over time – both in terms of market risk and the risks specific to you. An active asset allocation may also help you to benefit from the underlying aspects of individual asset classes over time. For example, some investments provide inflation-proofing, which can help at times when higher inflation threatens.

The skills in actively managing your asset allocation help with rebalancing too. Here, investments straddle two levels of risk, with funds moved periodically from the higher-risk to the lower-risk portfolio. This more cautious portfolio is used to fund short-to-medium-term needs, protecting that capital from large market swings due to the types of investments used, and helping to mitigate sequence risk.

The more aggressive portfolio is usually invested in assets such as equities and property, which can help mitigate inflation and longevity risks. When profiled together, the risk exposure should be the same level as that following an informed risk-profiling approach. Managed in a single portfolio, however, your wealth may erode owing to the competing needs of longevity risk and sequence risk.

How can wealth managers help?

First of all, not all wealth managers are equal. I appreciate you may view this statement sceptically, but the support you need throughout retirement should be broad as there are a number of aspects to balance.

Second, you should make sure your wealth manager is able to proactively manage your affairs in a tax-efficient manner depending on your unique circumstances. It is also important as you may need to sell down your investments in a particular order depending on your situation.

Last but not least, you should also find a manager who you can trust and who will still be managing your wealth with the same due care and attention in the decades to come, and who has a track record in Jersey. After all, it is only much later along your timeline that you will really be able to assess whether the support provided has led to a life well lived.

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