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How retirees can smooth out gaps in their income and stay comfortable


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The perfect income storm arrived for investors this year with the global spread of COVID-19.

Fanning volatility on investment markets, the financial fallout from the virus has led to further interest rate cuts and some companies reducing or halting their dividend payouts to shareholders.

If you're a retiree, especially if you don't qualify for the age pension or only receive a partial pension payment, generating income for living expenses has become much harder.

sponsored smooth over gaps in income

The Association of Superannuation Funds of Australia (ASFA) estimates a retired couple currently needs to earn $40,380 a year to live a "modest lifestyle" and afford basic activities. The figure for a single person is $27,902.

To live a "comfortable lifestyle" and support a broader range of activities including travel and the purchase of discretionary items, ASFA estimates a couple needs $61,909 a year and a single person $43,687.

But they're very big income targets. Interest rate returns are at record lows, and distribution returns from higher-risk assets such as shares are increasingly unpredictable.

Vanguard research shows that back in 2013, an investor could readily achieve a 4% annual income withdrawal rate with half of their money in shares and the other half in bonds.

These days one would need to almost double their risk and put all of their money into shares to get the same income result.

graph anguard yield

Thinking in terms of total returns

So, is there a different way to approach the funding of your retirement lifestyle?

The answer to that lies in looking beyond the generation of income returns as the only means to fund your spending, especially in retirement.

And that involves a shift in mindset by taking into account the "total return" from your investment portfolio.

What is the total return? From an investment perspective, the total return includes the increase in the value of your assets (the capital return) as well as the income they generate along the way.

In other words, a total return strategy incorporates using both your capital and your income returns.

How does such a strategy work in practice?

Firstly, you need to assess your broad income needs and your tolerance for risk. And then you need to allocate your available investment savings in a way that can support your regular spending needs on a sustainable basis.

Smoothing out income volatility

Capital growth and income returns, as we've seen recently, are unpredictable over the short term.

That's where a total return strategy comes into play. During times when your income returns fall below your spending needs, the capital value of your portfolio can be spent to make up any income shortfall.

What that means is that you'd need to sell some of your "liquid" assets (those that can be readily converted into cash) such as shares, exchange traded funds (ETFs) or managed funds.

Over the long term, this approach can help to smooth out income gaps when investment returns are more volatile or negative.

When investment returns are stronger, a total return strategy involves maintaining or even reducing your spending levels and using your extra money to invest back into liquid assets that can generate both growth and income.

The benefits of a total returns approach

A total return investment approach is all about establishing realistic spending goals and using your capital and income returns to achieve them.

At times you'll need to adjust your spending habits to account for times when you need more money - such as to take a holiday, for healthcare, to do house renovations or repairs, or to buy household or personal items.

At other times you may be able to reduce spending and use your income to buy more assets so you have more of a financial buffer for times when investment returns are lower.

It's a bit of a juggling act, but it's all about setting financial goals and expectations, and being disciplined.

Having a well-diversified investment portfolio spread across liquid assets such as shares and bonds will offset the risks of being too exposed to just one asset class and enable you to access your money whenever you need it.


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Tony Kaye is senior personal finance writer at global funds management group Vanguard Investments. He has held senior roles on The Australian Financial Review, The Australian, The Age and The Sun.
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