The Art of Decumulation
For some, a perfectly executed decumulation of wealth means the cheque to the undertaker bounces. Regrettably, perhaps, few people can manage such exquisite timing, writes Martin Hawes.
21 November 2023
A lifetime of finance comes in two stages. The first stage (the accumulation) is about growing wealth; the second stage (the decumulation) is about using your savings and investments to give yourself a good steady income in retirement.
It may come as a surprise to learn that the second stage – decumulation – is by far the harder.
Decumulation is hard because most people in retirement now spend not just the returns from their investment capital, but actually spend the capital itself i.e., they augment the returns that they get by running down their savings and investments.
To decide how much to spend means there is a fundamental tension between spending enough to have the best retirement possible but without spending so much that the money runs out before you do.
For some, a perfectly executed decumulation would mean that the cheque to the undertaker would bounce – that is you would go out on the last dollar.
The rate of drawdown
Regrettably, perhaps, few people can manage such exquisite timing. Instead, we may overspend and run out of money (most people’s greatest fear) or we play it safe and underspend and forgo things and experiences that we could have had (which is what people do).
The rate at which you can draw down on the portfolio is probably around 5 per cent p.a. That means that if you had $300,000, you could draw around $15,000 p.a. for about 30 years before the money was all gone. This is a rough guide – the figure is probably somewhere from 3.5 per cent to 6 per cent and depends on such things as your age, life expectancy, investment returns, and whether you will increase drawings with inflation.
This is not a matter of simply drawing on the cash returns (dividends and interest) as people used to do – instead you will continue to draw on the portfolio at a steady rate regardless of what is happening in the markets (after all, you need to buy groceries and meet your other regular expenses). This can be quite uncomfortable for some people as they watch the decline of their investment capital.
The drawdown rate assumes that you have adopted a conventional investment strategy. This would be a well-diversified portfolio with money spread across all the main asset classes.
There are a few retirees who adopt different strategies – e.g. they buy a rental property with the aim of living off the rent, or they invest solely in term deposits and roll these over as they mature.
Neither of these investment strategies is a good idea: rental property is a single asset which may not perform – e.g., houses are subject to politics with changes to the taxation or possible rent controls. Moreover, property is an asset class where it is difficult to access capital; unlike more liquid investments, you cannot draw cash from property on a regular basis.
Nor is the term deposit strategy right for retirees. The after-tax returns from term deposits are volatile; in the last couple of years gross returns from term deposits have varied between less than 1 per cent to more than 5 per cent. In any event, the returns from term deposits after tax very often do not keep up with inflation (they certainly haven’t in the last few years).
The best store of wealth invented is the diversified portfolio – and this is the best approach for retirees. This means that you have exposure to all the main asset classes (shares, listed property, fixed interest and cash) and that within these asset classes you have a wide range of investments (i.e. you own shares, many fixed interest investments, etc.)
Each asset class may perform differently depending on the prevailing economic conditions. Retirement may be for 30 years or longer, and over that time anything may happen. The whole point of a diversified portfolio is that one investment class will perform while others are not.
Diversification should extend to investments outside New Zealand. For example, most likely you will have global shares in your portfolio to cover you from something bad happening to NZ. Think about a major biosecurity breach (e.g., foot and mouth disease) and think further about what would happen to your retirement in the resulting economic and currency collapse – international investments would act as a kind of insurance.
In most cases this will mean using managed funds of one sort or another. For example, you may use a KiwiSaver fund – people over 65 can put money into a KiwiSaver and take it out again. Some people may establish an investment account through a financial adviser and have them make their investments.
A small number may take a DIY approach, but be careful with this: few people have the skills or are prepared to devote the time to managing their own investments.
You will only have one retirement and getting your investment strategy and drawdown rate right is critical. If there was ever a time to get some good advice, this would be it.
Martin Hawes is a financial author and speaker. He is not a Financial Advice provider nor a Financial Adviser. The information contained in this article is general in nature and is not intended to be financial advice. Before making any financial decisions, you should consult a professional financial adviser. Nothing in this article is, or should be taken as, an offer, invitation or recommendation to buy, sell or retain a regulated financial product.
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