If you’re considering retirement or have recently retired then it’s likely you have reached the point where you have stopped saving (accumulating) into your retirement portfolio and are now spending (decumulating).
So have you worked out what you can afford to spend each year? Are you planning to try and ensure your money runs out at the point you die or are you planning to leave a legacy for your children?
If your spending is relatively simple to predict and you do not like risk then you may be able to secure enough income from your retirement portfolio that you need to worry about investment risk. Think pension annuity or defined benefit pension.
However if you are looking for more flexibility from your retirement portfolio there are many dangers of pension drawdown.
Even if you feel you are more than prepared for retirement both mentally and financially, the planning and management of your retirement portfolio should never stop.
No matter how much money you have saved and how secure your income, these 3 factors can severely impact the quality of your retirement.
The worst case scenario for your retirement portfolio
#1 – You live too long!
It sounds a bit odd to say that living too long is a bad thing, but it is if you outlive your money.
Most people will underestimate their life expectancy. You can check your current Office of National Statistics forecast for life expectancy here.
However I believe even these forecasts are too low. I have a keen interest and spend quite a bit of time researching technology and future trends and I believe the improvements in biotechnology are going to greatly increase the length and quality of our lives. I would urge you to read Jim Mellon’s book ‘Juvenescence’ to find out more on this subject.
#2 – Inflation reaches 1975 levels
Living through a recent period of low inflation it is easy to forget just how high and fast the price of goods and services can increase, and this is one of the biggest problems for people who secure their income without some form of inflation protection.
If you remember back to 1975 it was around this time that inflation jumped to around 25% and remained above 10% pretty much all the way until 1981!
If this scenario happens again you are going to have to reduce your spending significantly, but if you can’t, your money is going to run out quicker than you perhaps thought.
#3 – Poor stock market returns
This doesn’t just mean negative returns but also lower returns than you were expecting. If this happens during the first 10 years of you making withdrawals from your retirement portfolio you are far less likely to see your money surviving longer than you.
How much can you afford to take out of your retirement portfolio
So when starting to make withdrawals from your retirement portfolio what is the optimal rate of withdrawal you should be making to ensure it can withstand the worst case scenario?
Well this is where you need to fully stress test your financial plan.
You need to model the above 3 scenarios and other scenarios that are relevant to you so you can see if your plan is robust.
This is what we do with all of our clients.
- Create a timeline, extend that timeline way past age 100 to show the effects of living longer than predicted.
- We test their plan over various historical time frames using the worst case scenarios of high inflation and low stock market returns.
- Clients can see how their finances may look at different stages of their life which allows them to know where they stand and what they need to do.
From this we can determine a rate of withdrawal that a percentage chance of success you are comfortable with.
Nothing is ever 100% certain. Even a secure income from an annuity or defined benefit pension is not risk free, however we can ensure your plan is robustly tested as much as possible.
If you would like a demo of our retirement stress test then please get in touch.
Stock market linked investments and any income from them, can fall as well as rise and is not guaranteed. Any figures quoted are for illustrative purposes and should not be taken as a forecast or guarantee. Past performance should not be seen as an indication of future returns and clients may get back less than they have invested.