It can be a worrying time for Australian near-retirees when the share market falls. Many of them are intending to rely on ASX shares and other income-producing investments to fund their retirement.
So, when the S&P/ASX All Ordinaries Index (ASX: XAO) slumps by more than 12% — as it has done in 2022, retirees can get nervous.
Introducing Minchin Moore Private Wealth partner and principal, Ben Smythe, to provide some tips.
What can retirees do about market volatility?
Smythe writes in the Australian Financial Review (AFR) about "the reality of sequencing risk [becoming] more of a concern" for Australians near retirement.
Smythe said:
Sequencing risk refers to the sequence or order of returns – specifically negative returns – occurring at the same time you start to draw capital from your SMSF (self-managed superannuation fund) to fund your retirement.
A bear market in terms of investment returns at the outset of retirement can cause significant stress on the capital supporting your retirement. The amount of stress will be dictated by your living expense drawings and capital set aside …
If you are forced to sell assets that have deflated in value to fund your living expenses, the ability to recoup that realised capital loss will be incredibly difficult.
Here's the good news… interest rates are going up
Smythe explains the importance of a cash buffer:
… recent market volatility is being driven in part by aggressive cash rate rises by central banks, which are starting to translate into higher returns on cash and term deposits.
Building a cash buffer as you approach retirement is an incredibly powerful tool to reduce the impact of sequencing risk as it allows you to draw your living expenses from your cash bucket as you enter retirement rather than solely from other asset classes which may be far more volatile.
The role of cash in your portfolio should simply be to provide liquidity and nil volatility. The added bonus now is that can also earn quite a reasonable return.
Regarding how much cash you should hold, the general rule of thumb is for retirees to aim for at least two years of living expenses.
This balance will ebb and flow with withdrawals and investment income received but if you can aim for this target, it will provide a buffer if there is a prolonged bear market affecting the other asset classes in your SMSF.
Can you buy ASX shares with your cash buffer?
Smythe says the other advantage of cash is being able to trade off some liquidity for higher returns.
… a high cash buffer allows you to better segment your investments in bond and credit holdings if you are not necessarily relying on either of these investments for liquidity.
Credit investments in particular will offer a higher return if you are happy to forgo liquidity, which could meaningfully add to the expected returns from your defensive component.
If you can capture a higher return from your defensive assets to compensate your declining growth assets, once again this will help mitigate sequencing risk causing damage to your portfolio.
'Equity markets will have more good years than bad'
Smythe concludes:
In most cases, those long-term capital market returns should be satisfactory if the investment strategy is well-thought-out and you have a suitable plan to fund your cash flow needs in the "bad" years.
