Save your retirement with the right preparations


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Retirement is an exciting time because finally the world is all about you. It's time to throw away your alarm clock, spend time with your grandkids, meet friends down the golf course or out at a winery and forget about work.

Thanks to superannuation and your efforts and planning, you are likely sitting on a nice pool of cash, and aim to invest it to get an annual stream of income to maintain your lifestyle during retirement.

For many of us that means things like term deposits, managed funds, and share dividends, or joining the one in five households that invest in property.

budget 2020

However, a large spanner in the works means that, without the right preparations, your carefully constructed plan could unravel.

That's because, in the current market environment, many retirees may fail to get the return needed to maintain their lifestyle because they have been caught off-guard by COVID-19.

For instance, if you were to deposit $1 million at current rates it would yield an income of less than $10,000 a year, which is significantly below the poverty line defined by Australian Council for Social Service threshold income of $22,516.

It's because the interest rate on a three-month term deposit has fallen below 1%%.

That is why savers are in so much trouble and many retirement plans are potentially in disarray.

Take a couple that wanted a higher return than a term deposit and bought shares in the big four banks, with the aim to use dividends to fund their lifestyle. It's been a strategy that has worked for many years.

But last year, in response to the economic challenges of COVID-19, regulators asked the big four to put restraints on dividend payouts. The result was NAB cut its interim and final dividend by 64% compared with the previous year, ANZ cut interim dividend by 69% and final dividend by 56%, while Westpac did not pay an interim dividend and slashed the final payout by 60%. Due to a timing issue of when it pays dividends, the Commonwealth Bank of Australia, had already paid out its interim dividend before regulators stepped in, but its final dividend dropped 58%  according to company ASX filings.

Dividend payouts bounced back this year,  investing fordividends is not without risk. Companies may have a policy on how much of profits will be paid in dividends but it is not a promise. If unforeseen events lead to lost profits or the outlook becomes uncertain or even if the company decides to use its cash for a big purchase, any company can cut or stop dividends.

COVID-19, the Delta variant and the path from near-zero interest rates

COVID-19, particularly the Delta variant, changed everything and ultimately lea to the Reserve Bank of Australia (RBA) cutting the cash rate to a historic low of 0.1% in November 2020.

In October, the RBA board voted for the fifth consecutive time to keep rates at the historic low, and our forecast is that the first rate raise will not be until late 2023, which is a little short of the RBA's expectations.

The November cut, and those preceding it during the pandemic, were primarily aimed at restoring job growth. RBA governor Philip Lowe, also warned interest rates would not increase until inflation is sustainably within the 2-3%% target range. The RBA does not expect that to occur before 2024 - even if the first rate rise comes a bit before the RBA's current expectations, it still means near-zero interest rates for more than two years.

With rates next to zero it has had a major impact on the income stream people can receive from savings accounts and term deposits, and after inflation and tax most such investment avenues would actually be providing a negative return.

Nevertheless, the savings rate of the nation has been resilient, and was 9.7% in the second quarter this year, compared with 22% in the same quarter in 2020 when the pandemic started to surface. It indicates households had fortified against income threa, like job loss but are now relaxing their guard a little.

While retirees are not generally worried about a job, they are concerned about generating an income from their investments and wealth preservation in order to maintain their lifestyle.

Given the previous safe ground of savings accounts and term deposits for retirees to earn an income has shifted, it's not hard to imagine they are struggling with how to counter the impact of ultra-low interest rates.

Three income investment strategies retirees are missing out on

  1. Investment-grade corporate bonds.

This is a loan you make to an issuer, such as financial institution like a bank, or a large local or international company. You get paid regular interest payments, and at maturity the money you invested is returned.

The risk you carry is that the company gets in financial trouble and defaults on its obligations. However, investors can take comfort from knowing that the rating has been researched and issued by one or more of the three international ratings agencies.

Investment grade bonds are generally a favoured asset class in periods of economic uncertainty, as they are not subject to the volatility of equity markets and some other asset classes. This is likely to remain the case while the cash rate remains on hold.

  1. High-yield bonds.

These companies are not considered as financially robust as investment grade rated companies, and therefore you expect a high return for your investment. The terms and conditions can also be more complex, so if you think high-yield bonds may suit your portfolio, please seek advice to understand the risks and benefits in detail.

Retirees may ask what if the issuers go pear-shaped?  As a matter of fact, the default rate for investment grade companies in the world is only 0.02% and 2.4% default rate for high-yield corporate bonds.

  1. Floating-rate bonds

This is a type of corporate bond specifically suited to a rising interest rate environment.

The interest paid via coupons is subject to a floating rate tied to official interest rates, with distributions typically on a quarterly basis.  This is usually a shorter-term debt instrument, which would suit investors to position for a rising interest rate environment.

Selecting bonds with a shorter duration is another strategy if rising rates is a concern.

Rethinking your strategy

Formulating and shaping a balanced fixed income portfolio would help retirees in reducing risk, while also being positioned for different market environments in the future.

Diversifying a portion of your retirement funds into investment grade corporate bonds will help to enhance your retirement return in an ultra-low interest rate environment. It also provides options for buying international bonds to provide an exposure to sectors not available in Australia, as well as currency options to further enhance your returns.

This information is not advice and has been prepared without taking account of the objectives, situations or needs of any particular individuals. Any individual should consider if the information is appropriate for your own situation. Individuals are advised to obtain independent legal, financial, foreign exchange and taxation advice prior to making financial decisions. Citigroup Pty Limited ABN 88 004 325 080, AFSL and Australian credit licence 238098.

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Anthony Si is a Senior Investment Specialist at Citibank Australia. With more than 20+ years' experience, Anthony has combined instinct and knowledge to build professional skills in the Dealing room and Corporate Treasury on the institutional side. He also brings financial analysis and planning skills to the table for his wealth clients and Anthony knows not just where to invest but can explain simply the strategy being undertaken - that is a rare skill. A subject matter expert across various asset classes including fixed income, foreign exchange and structured investments, gained from his work experiences in America, Hong Kong, New Zealand and Australia. Anthony holds a Master of Arts in Economics, and a Bachelor of Business Administration in Accounting and Finance.