Diversification is sometimes considered a ‘free lunch’ in investing to accumulate wealth.

A diversified portfolio can provide better long-term outcomes because it is more resilient in times of market turmoil. Typical portfolios will include an allocation to bonds, or other defensive assets which should help protect the capital of the portfolio in a market downturn.

The goals of a retirement portfolio are different.

The focus is income generation rather than capital growth, so a resilient retirement portfolio aims to protect income, not necessarily the capital. This can be achieved through an investment that pays a regular income stream. A partial investment into a guaranteed lifetime income stream, such as a lifetime annuity can create a more resilient lifetime portfolio that aims to protect income and improve the potential legacy over time.

Income is the key to building a resilient retirement portfolio

A retiree needs their investment portfolio to deliver income through retirement. Volatile markets can be problematic because the retiree still needs income. 2022 was a double problem because bond investments didn’t provide the buffer they usually do when shares fall. If there is no resilience, the portfolio can become depleted while drawing income. Income can still be sustained if capital is still available, so a retiree might not realise the problem until it is too late to fix. An intended legacy can be eaten away to maintain the desired lifestyle of the retiree.

Having an allocation to a lifetime income stream product can help provide resilience as it will generate income for the retiree. This means that they may need to draw less from their investment potentially preserving its value for longer. Over the longer term, a guaranteed lifetime income stream can lead to a larger legacy. With income provided by the lifetime income stream, spending goals can be met with lower drawdowns on the other assets. If, as expected, these assets perform well over the long run, the total balance available might be higher than without the lifetime income stream. Despite the reducing access to capital for the lifetime income stream, the income boost in many situations can more than offset any capital drawdown for the overall portfolio.

A simple example

Barbara is a 67-year-old widow who has $1.5 million is total investments. (For simplicity assumed to be all in super). She wants to maintain a reasonably comfortable lifestyle with travel and entertainment, spending $75,000 a year, which will increase in line with inflation. If it all goes to plan, she would like to leave a balance of more than $1 million for her children and grandchildren to share. Barbara’s risk profile aligns with a 60% allocation to growth assets and 40% to ‘defensive’ assets¹.

Under these simplified conditions, Barbara will be able to draw the $75,000 a year, which would be $132,346 because of inflation by the time she is 90. She would also have a balance of $1.18m so it would leave her intended bequest comfortably.

But what happens when there is one year of poor outcomes? Consider a year like recent markets, where inflation spikes (to 5%) and both growth and defensive assets lose value (-16% and -4% respectively)². Assuming this only happened in one year, Barbara will have no trouble sustaining her income well past 90, but her intended legacy will be impacted. By age 90, her balance would be down to $445,000, less than half what she had planned. The impact of inflation over time is evident with her annual income needs $132,346 in 23 years (adjusted for inflation). At least she will be eligible for a partial Age Pension.

To limit the impact of a bad year, Barbara could have started with a more resilient portfolio. If she invested 20% into a lifetime income stream³ the legacy outcomes could be improved. With a more resilient portfolio, Barbara would still be able to draw $75,000 a year. By age 90, her wealth would be down, but she would still have a balance of $614,000 to her name. This is almost 40% higher than the standard portfolio without a lifetime income and based on the simplified conditions illustrated above.

A resilient retirement portfolio can boost a legacy

Over the longer term, a guaranteed lifetime income stream can lead to a larger legacy. With income provided by the lifetime income stream, spending goals can be achieved with lower drawdowns on the other assets. If, as expected, these assets perform well over the long run, the total balance available might be higher than without the lifetime income stream. Despite the reducing access to capital for the lifetime income stream, the income boost in many situations can more than offset any capital drawdown for the overall portfolio.

The chart below plots the balance⁴ at different ages. The remaining balances are enough to provide the income Barbara wants, except for the standard portfolio which will run out at age 96 in the market dip scenario and she will be reliant on the Age Pension.

Balance available for Barbara's estate over time

A resilient retirement income portfolio can help to provide:

• target income for longer; and
• a higher balance as a potential estate.
   

In the event of a market dip at the start of retirement, a resilient portfolio may cushion the impact for a retiree. Its focus on providing regular income in retirement helps allow other investments to recover, leading to longer term growth and a potential higher estate balance.

¹ Growth returns are assumed to be 8.0% p.a. after fees and defensive assets 4.0% p.a. Inflation is expected to be 2.5% p.a. the 60/40 portfolio will deliver a real return of CPI+3.9%.

² Modelling uses a fee of 0.6%.

³ This example of a lifetime income stream uses a Challenger Liquid lifetime flexible lifetime annuity purchased on 25 September 2023. The $300,000 investment would pay $15,828 in the first year and payments would increase in line with CPI inflation. A death benefit (of up to $300,000) would be payable in the event of early death. No death benefit would be payable from age 87.

⁴ Higher death benefits payable up to age 77 under the Capital Access Schedule for the lifetime annuity.

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