Episode 42 - When is the right time to retire?
When is the right time to retire? Plenty of people will say 'as soon as possible' but is that always the right time? In this episode we look at some of the issues of when let your job define you and what happens when you no longer have the job. We discuss some pitfalls of retiring too early as well as leaving it too long and finish with some tips to make the transition easier. Have a listen.
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Welcome to this episode of the masters of finance podcast. Today Chris and I are going to be talking about sequence of return risk and thinking about what is it was going to look at what's a safe withdrawal right from the portfolio and why that matters. Look through some examples of how sequence of return risk can impact portfolios. And at the end, stay tuned because we're going to cover off some of the things you can do to try and mitigate or reduce the impact of and make sure your portfolio lasts a bit longer. Have a listen. Chris Hagen and Alex Hont authorized representatives of miranne partners financial planning, any opinions expressed in this podcast are solely our own and do not reflect the opinions or views of Moran Partners, financial planning or any entity we are associated With this podcast is for informational purposes only and should not be used for support as a constitute investment advice. Okay, Chris, welcome back to another episode of the masters of finance podcast. Morning everyone. Welcome back. Oh you bet I'm well thank you. We did have a little office Christmas party yesterday and everyone was Lovely. Lovely. It was good. It's nice to have the afternoon off and have a bit of a relaxing just have a chat was good. Yeah. And not talk about work. Yeah, it was good. Yeah. Partners role there. So that tended to help it sort of breaks up the the office chat because invariably you would probably end up there. But so does it that make this Christmas podcast? I reckon we'll try it Well, probably does. Because I reckon this will come this will be the last one that comes out before Christmas. I reckon we might end up recording one before the Christmas break so that we've got enough content and podcast coming out over your summer. When you've got that, you know, you listen to all the podcasts all that time and he's still waiting. He's still hanging on for all those hours. What's that? Crazy bit of movie car. That's my mood my Carl I'm sorry. That'll have to wait. I was just gonna say very unprofessional was Chris. I wasn't expecting that to kick in so quickly. I was going to say yes whilst you're on holiday and you can listen to well, dulcet tones about all the financial things impacting your life. I promise I'll get Chris more excited so that it's you know, it feels like a festive summer break. That Yeah, well, Merry Christmas to everyone. Happy Holidays. Hope you're all traveling safely spending some time with family. And we're getting a bit of a break from work. Exactly. Right. So what are we looking forward to bit of removal of myself from the world? Yeah, that sounds fun. But let's get down to business crazy to it. What is happening today on the podcast, it's a topic I think it's pretty important especially for those who have either just retired or relatively close to retirement something definitely to consider And it's we call sequence of return risk sequence of returns. It's a lot of words don't mean a lot. Most people when you put them together like that, but let's let's start by defining it. So, sequence of return risk is really the danger that the timing of your withdrawals or the from Super, and the returns that you generate have a negative impact on the balance now that that, let's put that in simple terms. What we're saying is when you start retirement and you start drawing at income or drawing money out from your investment portfolio, the returns that you get in those first few years have a huge impact on how long your portfolio is going to last. Right? So I know it sounds obvious, but if you have negative returns, it's going to allow it's not going to last very long, positive returns, it's going to last a lot longer. Because the key differential here is that this is the first time that your portfolio will see you Rather than having additions or accumulation of return like compound, the compounding effect, you actually start withdrawing funds from your, your pot. And so if you if you run into three or four or however many years of negative returns whilst you're actually withdrawing from it, rather than adding to it, that has a has a big impact. So let's focus on a couple of key points in this, this topic. And the first one, let's focus on is the withdrawal, right? And then I want to go back to this idea of the sequence. Yep. And, and these these two things have play a big part in the outcome of how long portfolios how long your retirement assets are gonna last. Now, just for what we're talking about today. We're not taking into account the the age pension. So you know, if you run out of money in Australia, you would be entitled to an age pension wants to override your pension age, right? So we're just going to disregard that because this is really around manage portfolios rather than that your overall cash position, but so just bear that in mind. So let's go with the withdrawal rate. There was a study done by a guy named Bill bangin in 1994, which was published in the Journal of financial planning. And he identified that 4% of your account balances the safe withdrawal, right?
Yep. So typically, this is what most planners will work off just to sort of say, you can take 4% from your portfolio every year without making or having significant detriment to your long term, I guess. Asset asset positional asset, longevity. Yeah. And so it's basically whatever your income is that you need. You need 25 times that in terms of capital balance. Yeah. Which is a lot. Rice is only and for some people, you might not be able to get that like it just physically might not be possible given your proximity to retirement, how much you've already got have How much have you saved? Already? So, you know, first, I think for some people can be if you're working strictly off this formula, it can be a bit. A bit daunting. Yeah. And now when that when Bill was calculating this, he did. He didn't nominate a writer 4% because he wanted to account for things like inflation. And we know that inflation erodes the value of money over time. And therefore we need to be generating a high This is not the right rate of return that we're getting on the portfolio. By the way, this is just the right of withdrawal. And that's Yeah, that's something that I think gets confused quite often when we have this discussion with clients is sort of always saying, well, we can withdraw or generate a rate of return. That's X percent, let's call it full. And then I think the what people hear from that is, you know, we're going to get a 4% return, which doesn't seem fantastic, but we're just talking about the, the withdrawal perspective. Yeah, yeah. And the other thing Well, and yes, so when we're looking at withdrawal rights and an inflation, if we if inflation is running at 2%, for example, and we're withdrawing 4% from the account, that means we're breaking even every year, right? If we can, if we can generate a 6% return, yep. Right. So, so that's covering the effect of inflation correct. Now, depending on the way your portfolio seats on the asset allocation, you know, growth defensive spectrum, you know, how much you've got allocated to shares and property versus how much you've got allocated to cash in turn deposits or similar investments will depend on the kind of the long term expected return you're going to get what do you expect to get over a period of time of usually we'd like to look at five years or longer. So through what we would typically call the investment cycle or economic cycle. So we would still hope to get more than six probably on some of the balanced or more aggressive portfolios over time. Yeah, definitely. I think we we both have pride in the fact that we'd rather under under Shame or underestimate. And then in reality, the like, if we look at the 10 year returns from this point backwards, I know it's a bit skewed because it's, we at this point, if we go back 10 years, we're picking the bottom of the financial crisis. So things are going to look good. But like say a balanced portfolio is looking at around 10%. Yep, annual sounds. Yeah, somewhere around there,
somewhere between eight and 10.
And yeah, as you said, you picking in that period if it even if you go back over longer periods, you probably in that ballpark between sort of seven and nine more often than not, yeah, and whereas we're talking about six is here, so you know, we would like to under under assume, yeah, so that 4% safe withdrawal, right also in buildings research was to try and account for the sequence of return risk, right, and and it comes back to the nail let's get back to the out of the pot about the sequence. Alright, so we've got an example in front of us which we will put in the show notes and for that, you can look at which shows are Two portfolios, I am be starting with a balance of $100,000. Ah, now based in this particular example, with these not numbers, these are someone else's. So they've picked $5,000 a year as they withdraw, right, so a 5% withdrawal rate from the starting balance not not not adjusting every year, just withdrawing $5,000 every year, I've got 25 years worth of returns. And what they've done is in one portfolio, they've got them starting from you, from you zero get down to you 25. At portfolio a, and in portfolio Bay, they've gone from you 25 to easier so I've just changed the sequence and reverse the sequence. Both wore this there were returns over that period of time, have both averaged 6.8% per year. And the standard deviations of this returns are 12.8%. It's the same data set it's just reverse the sequels gonna say for those who are mathematically minded out there, like the sum of all the returns divided by the number of years gives you the same average and obviously, the variability Exactly the same because it's, as Alex just said, it's the same data set. So there's no, no statistical difference between it's just the
the when the returns land.
So the keys exactly when the returns land in portfolio I, the first year, the first three years returns were minus 15%. You and minus for you to minus 10. year three, and including the 5%. Withdrawal, the $5,000 withdrawal, right? We are now the portfolio balance is now just under $61,000. So it's nearly a 40% reduction over those three years, which is huge, because you know, in this scenario, let's put a let's round this up. So it's a bit more realistic. Let's say it's instead of 100,000. It's a million. Yeah. We're sitting with started with 1,000,001. Now sitting around about 600 off the three of us. Yeah, yeah. So I'd say the massive reduction, compare that with portfolio be, which now these are big returns that they've got in there for this example. One was 22%. In the positive, YouTube was 8% positive and the three was 30%. Positive, right and the difference in the balances at at the study for including Jordans, the balance is 154,000. Let's call it $300. So it's been a nearly a 50% increase, right compared to a 40% reduction. Now I know that sounds silly when you think about it, yeah, one fulfil, I had three years of negative returns one before I had three years of great positive returns. But the point is that we're using the same return data over 25 years with the same average rate of return and let's go back, let's go to the other end now. Right? portfolio I that has those negative returns at the start, but then it starts to turn around and like moved more towards those positive returns towards the end. problem is they run out of money and you 19 right, portfolio day, which had those positive returns at the start, but then has that starts to move towards those us where they have very poor returns towards the end still finishes the 25 He's with a balance of 240,000. So they've gone up by 140,000. That's a big difference, though, in terms of longevity to one runs out at 19. Yeah. And one still has 240,000 left after 25 years. Yeah. So there's six years just in this projection plus, okay, for withdrawing $4,000 a year. You know, there's probably another, you know, 1015 years on that. What? Yeah, comfortably.
Yep. So it makes a big difference.
So the point we're trying to make is that those first few years of retirement, when you stop contributing, and you're drawing money out, have a huge impact on how long your money is going to last. In fact, any you know, any ease that you have really bad, a string of really bad use is always going to have a big impact as a big risk there. So for the retirees out there who are listening, this is something that sum is pretty important because we've all been I think we've all still got the financial crisis in the in the back of our heads because it was, what, 10 years ago. I don't think the the psychological aspects of that have necessarily lift because every time there's a bit of a dip,
these conversations arise, which is fair enough.
Yeah, there's there's not a lot of our should we Right, right. Yeah, exactly. Right. What happens when the when we fall 50 60% what we did 10 years ago, so it's, um, it's definitely a conversation that way internally within the Office of very cognizant of. Yeah. So what do we say? Well, I mean, he's, he's some bad news, Chris. The Rams radio spending in retirement, is that what we say is that you're spending in retirement is probably at its highest, the ease after you start it. So he's after you stop work. So when you start drawing an income, right, so those first three years, probably when you're going to draw the most? Yep. And this ties in with the whole retirement clip discussion that, you know, in the previous podcasts that we've had with Paul way back around probably Episode 20 somewhere around there but you know, you've been working all your life with you got lots of free cash flow kids have left the house, if you've had kids, you know, you last name pretty easy, then you finish work and all of a sudden you you're drawing and you're, you're, it's very difficult to just change your spending habits overnight. It is but also I think as you get a bit older you you spend you go out a little bit less, you might try not traveling to the same degree as you would in those early years when you're fitter and healthier. You know, you're just not as well you know, just get a bit older, it's a bit it gets a bit harder. So what we say is people spend a little bit less from probably the age of 60 down to a bit on to age 75. about age 75 was when spinning off and bottoms Yeah, yep. And then once we get beyond 75 spinning start to increase again because there's a higher medical bills and associated with that at all. also associated with a lot of anxiety around, will my money last long enough? You know, my spending is going up on drop my I can see my portfolio balance reducing. This is an issue. So you know, at this time when you spending starts to turn from the bottom, there's also a lot of financial anxiety that comes along with that. Yeah, yeah. So I guess this is leading to the perfect storm where, you know, you, you don't want those negative returns in the early retirement. You're also withdrawing more often withdrawing more than spending more than you might in other us like that you will later on? Yep. To draw you balance down. So that's this, these first few years become pretty critical. And this idea of sequence of return risk is a real thing that can have a big impact on their followers definitely turn and look typically I think within the industry, the answer to that is to lower your risk profile.
Yeah, so let's take take less risk.
Yep. Which means you know, where there's less likelihood of the fact that these portfolios again, as suffer, year runs have years of negative returns. What that then also means is that your likely return figures also lower cost, you lower the risk of negative returns, you actually lower your overall risk. Now, if you're in a position where you've got an asset base that you can do that that's okay. But I would say the large majority people don't. Yeah, and I think the problem is that we've still got 25, right, we've got this money is going to last for 25 years. And there's a big difference if we're only getting 4% return versus 6% return, they might not sound huge, but in terms of the longevity of the money, even that difference is massive. It will because again, as I mentioned at the start of the podcast, inflation is never going to go away. So you know that that the value of that although your say earning for and drawing for you're actually going backwards at two and a half to 3% a year,
which reduces your options later in life.
Yeah. So what can we do about these quiz? We've just spent the last 15 minutes Talking about how big a problem this is for retirees. How do we fix it? Yeah. So it really, your retirement is all about income generation. That's right. Oh, wait, hold on. Wait a sec. Say that again, Chris. Retirement is all about income generation. That's right. I'll be waiting to use that a bit more often. But anyway, so we got whining, we need income generation, because we need income to spin. I mean, that's not everybody's view. And not not certainly not say an industry super funds, you know, because they run on unitized funds yet, right. And with a unitized approach, where you have a unit in an investment, every time you need income, you have to sell units. So that's great when markets are when unit prices are high. You don't have to sell too many units. But the problem is when we say times of market stress, when we get those periods of negative returns in the unit prices, compress will go down. You have to sell more units for the same amount of cash. Right, right. And what's the problem the problem with that is then you Your every time all throughout your time at your unit balancing will be decreasing all the time, you will always have less units because you're selling them to pay pensions correct. So no matter at the at the start of your retirement, your pot is 100,000 units, hundred thousand units, whatever happens to be, and each unit has a proportional machop of the underlying investment mix. Yeah. And as I said, Every time you pull it, you make a pension payment you need to sell a certain number of units to to fund your income. So you selling capital and, and income. And then so we go through a period where we're seeing the balance of those units full because the underlying investments are falling. Well, naturally you're going to have to sell more units in order to fund the same level of income that you're currently Jordan. The other problem with the unitized up the thing is when you when asset prices doesn't matter, you units asset prices share prices doesn't matter what they are when something falls by let's Say something false 30%. Right? in value, it needs to go back up by 50%. To get back to you where you were, he was right. And I know that sounds silly. But if you did the math and said, If you know, if $100, you bounces $100 and it fell to $66, you know, you've lost a third of the value to get back to $100, that $66 has to go up by 50% of 66. To get back to the hundred, I'm talking random numbers here. So don't pull me up on my decimal points. But it's a different magnitude. Same with the unit process, right? So you know, same thing, if you're selling units at $66, you've got a lot less units, and they have to go up by 50% to get back to where they were previously correct. Because remember that you started out with a set number of units. So the more you're selling, the harder it is for you to get back to where you are, and you're not buying more units because you're not putting more money in correct, right. Yeah. So So how does that different from our cash flow matching approach very in the sense that rather than taking a unitized approach, do you have a portfolio and the design of the portfolio is to generate the income that you will will withdraw on a yearly basis? Yeah. So the point of this is to actually never sell investments, not not never. But you know, the idea is we create a portfolio with investments that pay regular distributions. And we're never having to sell units in terms of market stress, because we're, we're harvesting the cash, the dividends, the distributions that these things are throwing off, to pay for your living expenses to make the withdrawal, the withdrawal needs. Yeah, correct. And it just means that we have more options, more control over the portfolio, so that if we're going through a tough period, but we know it's probably not the best time to sell, whereas if we're going through a good period, you know, whether we sell or not, is sort of, I guess, up up to the fact that, you know, what do you need from your perspective and what do you think's best long term it just means that we have control over what we're buying and selling versus the other option where you're just basically forced to sell constantly.
I want to run through an example of, of one particular stock. And this isn't by no means a recommendation. This is only an example. And it's a storica. One and it goes back to the jfc. And I just wanted to illustrate the point that we can't we can't solve the problem of sequence of return risk, but not using this approach. We can certainly limit the the limit limit the damage and the downside. So Chris, do you mind pulling up the Westpac share price, three May, let's say the period of Let's 2004, three to 2012. And if anyone remembers, I'm sure lots of people remember 2000 and 723 to 2009. We had the global financial crisis as it's cold, where share prices, you know, share markets drops in the order of 30 40%. And listed property dropped the order of 50 to 60%. Yeah. So we took if you're a In a typical portfolio, you've taken a battering Yeah, so let's just look at the share pricing about to that sometime in 2004 crease. Alright, so I've pulled up first of November 2004, to the first of October 2012. So those of you wish to go to say yahoo finance or google finance and put in Westpac and pull up this date range. As of the first of November 2004. I've got a Westpac value sitting at $19 and 36 cents yet. And then if I look say around two First, let's look at let's look at the start. Let's look at the peak. Let's look at the bottom. And then let's look at the end of that period for shape process. So we started in 1919. And then we made our way up to the peak, which was obviously in 2007. And Westpac was at $28 14. So we've gone from $19 to $28. Yep, come down to sort of what is it March 2009 or something Like that she does and and on Westpac is worth $18 96. So we're only $1 off way we started in interestingly, after one of the worst falls in markets, right over that period of time. And where do we finish in in 2012 and 2012. We're at $25 34. So we've, over that period of time holding Westpac, we've made money on this on the price. But But what's interesting to note is that it went up by more than $10. It came back down, and then it sort of evened out to where, you know, to, to level it was probably more realistic in terms of growth over that period of time. Yeah, correct. And if you draw a line from start to finish, there's a nicely sloping trend line upwards. And then obviously, the the highs and lows around that yet, but if you looked at the percentage change over that period of time, so we've gone we've probably gone up by 50%, more or less on 25 to
or 19 to 19 to the two peak we went from 19 to 28. So let's just call it about a 50%. increase. Yeah. We went from 28 to 1628 to 16.
Which is nearly having.
Yeah, correct. Yeah. Right. So nearly 50% for we'll call it 45%. Fall in the share price, yep. And then back up to 25 and back up to 25. So, and we came up with another sets another 30%, on top of that 16 or thereabouts. So, it swung around wildly during this period of time, what happened with the dividend because this is the piece that I think is really powerful is that we look at the dividends that come out every six months. All right, and and I'm not looking at the right I'm just how steady they were. So 2004 44 cents, and then 4951 5667 63 So where are we at? Let's Let's go at the packet where what's the dividends the paid Chris 68 cents. Okay, that's when markets started falling off to that point where markets adjust started falling. So was the May 2007 was 63 cents. Yeah. And what's that? That's November 2007. It was 68 cents. And so we just gone over the peak at that point. Okay, what's the next one? The next one was 70 cents. So markets are falling and the dividend is still going up world is currently ending. Yep. And then the next one, which is may 2008, where we're almost at the bottom of the world ending. We went from 70 cents to 72 cents. So we still got a higher we still got our cash flows to cash flow still maintained during this period of time. Yep. So we've now bottomed on the share price. And the dividend after that went to 56 cents. Okay, so, it took a while, but we did say a dropping in the dividend of in the order of we looked at it over about a year when you putting these things together, was 24% was about 24 somewhere between 22 and 20. 4% so there is a reduction in your income over this period. But like what happens after that crease six months later, we went from 56 was the low. So let's go pretty much at the bottom 72 cents, which is as high as it had been. I can't see a dividend that was lower higher than that. Sorry, prior to that, yeah, then 56. So that's a big drop. And then so six months later, just 12 months after the high dividend, we're back to 60 cents. Yeah. And then and then the next 165. Okay, and then the next 174. So it took three dividends, you know, 18 months before for our income to recover. Yep. Alright, if we didn't sell any of those shares in that period of time, yes, we would have taken a bit of a hit on income at that period of time, which is not completely unexpected given the given what happened, correct. Right. And but at the end of the period of that period of time, area income is back above. Where was it the beginning? Yeah, it was before the crash, and the share process is higher than where it was before. The crash. So the point I'm trying to make is that even though we had some horrible periods of return during that, over that period of time, if you didn't sell the shares, you would have collected nearly, you know, nearly enough income along the way to make all your living expenses, and come out the other side, still holding on to just as many shares as you started with that are worth more than when we started. Yeah, correct. And I think the key thing is here that, you know, you build a diversified portfolio with a number of stocks all around the world in different sectors, both, as I said, here and globally. And although that was a fairly synchronized fall, from a price perspective, there's still the ability to generate the income that you need to draw. Yeah. So we, you know, that was what a really tough period of time to being the advice business, and it was showing all of, you know, all of our clients were saying, what do we do, what do we do and we said, Look, modern portfolio theory, or conventional portfolio theory says don't sell Yep. And anyone who didn't sell is come out the other side with more money than what they started with when we're looking at dividends. Correct, right the inclusion of dividends, not just Westpac but in other shares as well. Whereas I know that they were that one of the industry funds let slip that one of the time that they had the biggest movement from their investment options to cash was about March 2009, which is exactly exactly the bottom bottom of that of where the markets were, which was the worst time to come out. And anyone who did that would have actually realized those big losses, especially in terms of unit prices, where you've had to sell units to convert them to cash it definitely Yeah, sorry, I cash flow matching approach is not foolproof, as we said, we're not it. You can't avoid negative returns if you want to get that higher rate of return long term. But it is one way to reduce the impact of those big falls in markets.
And what this does is it means we don't have to see Well, we we still may wish to if it suits your personal circumstances, but we don't necessarily need to go really defensive on the overall portfolio to Try and avoid the sequence of return risk. So as I was just sort of said, you know, there's where it's a way to mitigate some of the more conventional approaches. So that you have more options and, and, and more money in the longer term. Now, we've put a lot of time and effort over probably nearly a decade into building these portfolios and building out how they work and why they work the way they work. So if you've got any interest, or you're worried about your balance, and you're worried about these sorts of events, we have a solution that might help. Yeah, exactly. So I think that's pretty good for that one, Chris. I'm happy. I think I've got everything I needed to sign up at about sequence of returns yet. I mean, isn't much else other than we might, as l said, Put some information up in the show notes, but obviously, always, if there's anything in here that hasn't made sense, just please give us a call and we're happy to discuss. All right, Chris. Now over Christmas break. Yep. What are you doing? relaxing first and foremost. And then we're off to tazzy to walk
off the track
in Tasmania. Walk the overland track. Oh, wow. Yeah. So yeah, it'll be nice. be interesting to be away from a for that long. But yeah, looking forward to.
I think I told you I walk the overland track but probably only about 100 meters of it. Yeah, I was saying I saw Santi yesterday I had a friend who of the 30 per day that they got released for them or airlifted out so yeah, I mean, telling the friends who are coming with us that they definitely need their ambulance memberships and be prepared. Yeah, correct. And I'm probably moving house over Christmas crews are exciting. I will have to move far. I'm moving next door. This we're doing we'll do a work to our place. So in the meantime, we'll have no kitchen or bathroom and so we can't stay there with two kids yet. So moving moving house, packed up and moving next door. And other than that, I'll probably be doing my usual tour of Victoria checking in and in Bendigo and probably Ballarat and saying, you know, the in laws and family. Yep. And yes, I'll be relaxing, playing video games jumping in the pool with the kids get try and get to the beach. You know, hit all those fun things. Sounds like a good Christmas holidays. All right. Well, I think that does it for today, Chris. We have another one coming out shortly, but you won't get it till after Christmas. So Merry Christmas everyone, everyone and we'll talk to you in the new year.
Thanks for listening to this episode of the masters of finance podcast. If you want to hear it again or hear any of our other episodes, you can find us on iTunes, Stitcher, or Spotify. Or you can also head over to our website at www dot miranne hp.com or you to find all the episodes and some other material that we have for you. If you want to get in touch with all the chrissa you can Find us on social media or get in contact with us through the website. We hope you enjoyed this episode and look out for the next one coming soon.
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