A formula for retirement planning

SINGAPORE - Most financial planning discussions are likely to focus on saving and accumulation towards a retirement goal.

But with more Singaporeans getting older and approaching retirement, financial advisory firm Providend has turned its attention to decumulation strategies - that is, helping clients navigate the stressful decision of how much to withdraw at retirement, and how to still preserve some capital for bequests.

After two years of study and development, the firm has come up with a framework, which it calls "RetireWell".

Says the firm's chief executive Christopher Tan: "We realise there are three things retirees look for. One is assurance of retirement income. When you are retired there is less emphasis on returns, and more on the reliability of returns.

"Two, there should be some level of safety especially at the early stage of retirement. And, the plan cannot be static; there must be flexibility to change as circumstances change."

Asset allocation

RetireWell seeks to take into account major concerns such as longevity or the risk of outliving your assets; inflation; investment volatility and overspending.

The framework basically divides up an individual's pot of savings into a number of buckets, each with its distinct asset allocation, investment horizon and expected return.

This concept is not unlike that of a bond investor who "ladders" his portfolio. This means that for a theoretical bond portfolio, for instance, instead of buying just one security, you buy 10 bonds to stagger the maturities similar to the rungs of a ladder.

This creates a consistent income stream and helps to mitigate interest rate risk.

In the RetireWell framework, the first bucket is the income bucket, which holds cash and near-cash assets for the retiree to draw upon for immediate income needs. Apart from that, there are six more buckets, with staggered investment horizons and varying asset allocations.

As each bucket nears the end of its investment horizon, the proceeds are transferred to the cash bucket for withdrawal. Generally the last three buckets will have the longest investment horizon of between 20 and 25 years, and increasing equity weightings. This is expected to generate growth and enable the retiree to have a bequest for his family.

Mr Tan says an important part of the advisory process revolves around ascertaining a pre-retiree's desired income in retirement, and his "retirement income floor". The latter is the minimum income that he is willing to receive.

"We think a retiree's risk profile is very different. His risk profile relates to the minimum income that he needs. If he sets a retirement income floor of 50 per cent, and for the first five years he wants $10,000 in income, then his minimum (floor) must be $5,000.

"If you want a higher floor, then you have to be conservative. With a lower floor, you are prepared to be more aggressive - that is, a larger part of the income may be more variable. This isn't a standard 'conservative, moderate, aggressive' profile that is commonly used."

As a theoretical example, take an individual, David, aged 59. His objective is that in the first five years, he wants $10,000 per month in income.

This will be reduced to $8,000 a month over 10 years, and finally $6,000 until age 83. The numbers are inflation adjusted at 3 per cent.

The income should last 25 years, at the end of which he would like to leave a bequest of $1 million.

He currently has assets of $1.6 million in cash, shares and managed investments.He has rental income from one investment property, and a CPF Life annuity.

He also has two endowment plans with maturity benefits of a total of $200,000.

The firm uses an income optimiser to determine how his assets are to be divided among the various pots. Roughly the cash bucket will take some 23 per cent of assets.

The first three buckets - representing fairly conservative portfolios of up to 40 per cent in equities - will take up another 50 per cent of assets.

The expected returns for these buckets range between 1.5 and 5.5 per cent. The investment horizons range between five and 15 years. The balance is allocated into three other buckets with expected returns of 6.5 per cent per annum, and investment horizons of 20 to 25 years.

The last bucket gets an allocation of about $220,000 or 14 per cent of assets. With an expected return of 6.5 per cent over 25 years, it is expected to grow to a tidy sum of $1 million, to serve as a legacy for his family.

One of the biggest concerns will be volatility. What happens if a crisis hits similar to that of 2008?

"There is a great need for an annual review, because we need to ensure the sustainability of the retirement income. If we had planned this in 1990, the assumptions would have been very high and halfway through we would have had to drop them.

"If there is portfolio outperformance, we could take profit and convert the proceeds to Bucket 1 (conservative portfolio). What is more worrying is underperformance," says Mr Tan.

Underperformance is likely to trigger discussion on whether the retiree is able to reduce his spending. If there is a market crash, those buckets with longer horizons and larger equity exposures may be hit hardest.

"A retiree need not worry because he doesn't need the money from those buckets and as we have seen, markets recover." For cash needs, assets in buckets that are more conservatively invested can be converted to cash. "The first approach is not to convert, but to try to spend less."

Low fees

It is early days for the RetireWell concept but Mr Tan says a number of clients have adopted it. The firm, which earns solely through advisory fees, expects that clients may end up paying less fees on RetireWell as assets in the income bucket such as fixed deposits and CPF Life will not be charged fees.

"Our approach is that we don't have to sell you anything. Some clients may have a portfolio of Reits, which can be in the income bucket and not part of the fee calculation.

There are many good income products which the financial adviser may be unable to execute for you."

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