Can late boomers avoid retirement bust?
A new investment strategy for DC pensioners
The savings challenges facing the last of the baby boomers and the earliest cohorts of generation X have fundamentally changed. The combination of low inflation, repeated financial crises, falling yields, lower levels of pension security as well as increasing longevity make successful retirement saving increasingly difficult1.
Against this backdrop, in this paper we explore the key issues a “late career” saver (for our purposes an individual over 50) should consider when investing both for and through retirement. Throughout the paper there is an assumption that the savings approach being contemplated is a secondary layer of retirement provision and the individual has a foundation layer from another source (most likely state provision).
We highlight two distinct categories of risk:
- Pre-retirement risk: that the individual fails to amass sufficient savings to stop working
- Post retirement risk: that the income from savings is too low or runs out
We propose that ultimately a successful decumulation strategy is only possible when it follows effective accumulation. Further, our analysis shows that an individual must continue to take the “right sort of risk” through both their late career and during retirement.
We show that the “right sort of risk” means taking both enough risk and the right kind of risk, i.e. that for every unit of risk taken there is a high pay-off in terms of return. Also we explore how both too little and too much risk can result in a high likelihood of failure in both accumulation and retirement. This is because during both phases averages are not outcomes, i.e. looking at averages does not give enough information to effectively evaluate each strategy properly. Instead investors should consider a wide range of metrics to understand the outcomes of an investment approach.
For the period just before work income stops, we look at the “retirement at risk” to understand the likelihood and magnitude of a shortfall that might delay decumulation. In the period during retirement we discuss the likelihood that an individual’s life extends beyond their savings.
For this retirement period we also show how the addition of reasonable longevity estimates to savings and income expectations can empower individuals to make informed choices.
Our analysis shows that the sole use of cash and/or bonds as pension savings is highly unlikely to generate sufficient wealth prior to, or during, retirement. However, a multi-asset approach offers the “Goldilocks” of investment trade offs: neither too much risk nor too little return and the most attractive return per unit of risk. In addition, both active management and systematic risk control can reduce the spread of outcomes without materially inhibiting return. This conclusion extends into the decumulation phase, where we propose that a multi-asset approach offers the best trade-off between delivering returns and protection against the likelihood that savings run out. Even though the moment when accumulation becomes decumulation is the point of maximum capital risk, the investor who wants to achieve prosperity in retirement should not completely de-risk as they approach retirement, but continue to take a multi-asset approach. In summary, therefore, the best strategy is not to completely de-risk at retirement, (into cash or bonds) but to continue to take a multi-asset approach and continue to invest through retirement.
The savings lifecycle
To put the rest of this paper into context, we start by reconfirming the likely position of today’s late-career saver. Set out in Figure 1 is the investment lifecycle of our “typical” saver. It shows that our late-stage career investor will already have accrued a reasonable amount of capital and now needs to turn their attention to savings and investment as they approach retirement and start to draw down on their savings. As our late boomer hits their 50s and moves from the “earning and saving” to the “approaching retirement” phase, they need to contemplate two key issues:
- How can they amass sufficient savings to be able to afford retirement.
- Once they have successfully accumulated sufficient savings to retire, how can they draw down an attractive income level and manage the risk of their savings running out?
The rest of this paper focuses on these two challenges.
1. Baby boomers are defined here as the generation born between the mid-1940s and the early 1960s, while Generation X is defined as the generation born between the early 1960s and the early 1980s.↩