What are the investment options for those contemplating retirement in the current investment environment?
Traditionally, the most common approaches adopted by retirees are interest-bearing arrangements such as cash or term deposits with banks or property-based investments.
Interest-bearing investments are attractive to risk-averse investors, but these investors can get caught out, as happened when many conservative mum and dad investors lost everything in the post-2009 period of finance company collapses – a misfortune not easily remedied without the ability to earn an income.
The more ‘vanilla’ approach for the average conservative investor is to put all their money in the bank. Given the track record of New Zealand banks, this doesn’t pose the risk to investors of losing all their savings, but may instead result in a loss of purchasing power, as illustrated below:
On-Call Interest - 1.6%
Tax 25% - 0.4%
After-Tax Return - 1.2%
Inflation - +/- 1%
Real return (after tax & inflation) - 0.2%
You can see from the table that although the return from the bank appears to be 1.6%, when you subtract tax and the decreasing purchasing power of your money (inflation), the real return is far less attractive.
Investors armed with this knowledge might be considering the more return-friendly approach of investing in residential and commercial rental properties. The benefit of this strategy is that it can provide both an income and a nest egg for retirement if investors who are willing to put in the work. However, finding a reliable tenant can be an ongoing problem, along with responsibility of paying rates, insurance, maintenance and the mortgage in the event of losing the tenant – not a prospect you would want to be facing during your supposed golden years.
There is another alternative that comes in the form of shares either in a private company, your own business or in publicly listed companies.
The potential returns of running your own business are excellent if the business is successful, but the downside risk is bankruptcy if the business fails. Private company shares may not see you broke, but you could easily lose all your money, as you have no exit strategy when things are no longer going well. At least with publicly listed company shares an investor can sell the shares on the market at the prevailing market price, but the risk of substantial capital loss remains.
This thought can be daunting to the average passive investor who doesn’t want nor has the necessary skills needed to manage. Just look at the littered corpses of investors who thought that they could ’beat the market.’
So, what is the answer for retirees wanting to maintain their preferred lifestyle but not risk running out of money before they run out of life? All will be revealed next month.