Lockdown Lessons: Retirement Dry Run
Circumstances don’t make the man; they only reveal him to himself. Or so goes the saying.
During this lock-down, many of us are discovering a side to us we never knew existed. For instance, it suddenly dawned on me that a certain teetotal chap who lives in my house now easily empties a bottle of wine every two days. The trouble is, he doesn’t feel guilty about it. If that doesn’t sound too bad to you, dear reader… you’re probably not what I would have described as teetotal before this whole thing started.
But I digress. My friend Dennis Hall of Yellowtail made a poignant observation on Twitter the other day:
’Is lockdown a glimpse into what retirement might look like without adequate savings? Shopping only for essentials, no travel, no entertainment, no eating out, walking becomes one of life’s pleasures. If it’s grim after a few weeks, what might 30 years feel like? Plan ahead.’
Is the lockdown a dry run for retirement, spending essential income only? Maybe not in the strictest sense. After all, under normal circumstances in real retirement, you’d be able to have family/friends round, visit a public library, move as you please etc. All without very much money. But the commonality between the lockdown and retirement on essential income is that your choices are strictly limited. Not by the Government, but by your income.
So what can we learn from this retirement dry run?
• For starters, the lockdown has demonstrated how difficult it is to nail down what is essential and non-essential (or is it discretionary?) expenditure.
Our definition of essential expenditure is a moving target coloured by our preferences at a point in time. A few weeks ago, my Netflix and Amazon Prime subscriptions would have been considered discretionary. Today however, they are as essential as the air you breathe. Furthermore, food and drinks are essential but a bottle of Prosecco every other night is apparently ‘discretionary’. It’s also essential to have a roof over your head but a nice house in a leafy suburb is a ‘lifestyle’ choice, obviously.
• The second, and perhaps the most important lesson from our retirement dry run on essential spending, is that hardly anyone would consider their retirement a success – or particularly satisfactory – if they could only afford the essentials.
This leads me to the ‘safety first’ approach to retirement income planning. This approach proposes that a retiree should first and foremost, use their retirement portfolio to secure essential spending, using guaranteed income sources such as annuities, whatever the cost. Only after securing the essentials, should they consider taking on investment risk to meet non-essential spending needs.
Contrast this with the alternative – the ‘probability based’ approach – which proposes taking on capital market risk. But on the basis that you calibrate your withdrawal such that it would be sustained even in the worst-case scenario. It makes no strict distinction between essential vs non-essential spending. Instead, it focuses on how much total income you’d have if things are really bad (aka sustainable withdrawal), which may even involve a rare prospect of dropping below the ‘essential’ for a temporary period.
If the cost of a guarantee means that a retiree can only afford to secure essential income, should they go ahead regardless, knowing full well that their options are permanently curtailed to the bare minimum? Or should they take capital market risk with the entire lot and prepare for the worse case scenario? Or shoot straight down the middle; secure say 50% of the ‘essential’ and take capital market risk with the rest?
Of course, if an individual can afford to secure their essentials using guaranteed income sources, while affording some of the finer things in life such as travel etc, they should. Retirement income planning would be much easier if this were the case for most people. But the reality for countless people at retirement is about taking capital market risk, with a real probability of a shortfall, even if temporary and a life permanently confined only to the essential. Or indeed, something in the middle.
One thing I do know is clients would scarcely consider it a stellar job, if all we managed to secure for them, was a guaranteed retirement on rice and beans.
• The third and final lesson is around the role of Government bailouts in making capital market risk bearable for equity investors.
Many people are terrified of investing in the capital market because they think, in the event of a systemic shock such as this one, the value of the their investments would just vanish into thin air.
The reality is, governments and central banks around the world detest major market declines as much as investors. During market crises, they step in to shore up companies and stop them failing, especially where there is risk that a large number of employees would lose their jobs as a result. They did during the 2008⁄09 GFC and they have once again done it during the ‘Great Pandemic Bear’ of 2020.
Clearly, the capital markets aren’t out of the woods yet. We can’t always count on the government to underwrite losses made by every single company, every single time. However, as we continue to invest in globally diversified portfolios consisting of the best and brightest companies in the world, it’s not credible to think that governments and central bankers around the world will sit and watch the world burn during an extreme crisis.
The upshot is this; bailouts benefit equity owners, democratising losses while gains are kept privatised. I’m not saying any of this is fair. But I’d rather be on the side of equity owners. 🤷🏿♂
PS, on a level, I do find the Safety First approach elitist - i.e. only (rich) people who can afford to guarantee all their essential spending should participate in the risk and return of the great companies of the world. But that’s a discussion for another day.