There are a couple of key things to think about doing when it comes to preparing for retirement and considering investment possibilities.
Don’t De-Risk Your Portfolio Prior to Retirement
The first do is actually a don’t. Don’t slavishly de-risk your investments and pensions in the run-in to retirement. I hear this ALL THE TIME from perspective clients on email and on initial calls. Words to the effect of: ‘I’ve started to move more money into Gilts as I get closer to the big day because that’s the right thing to do, isn’t it?’
Well, it might be, and as ever the key word here is to be intentional. We’re going to talk shortly about cashflow needs and timelines, and this will inform our need to de-risk or otherwise. But please, PLEASE, don’t just do this as a matter of course.
And if you’re in a so-called ‘life-styling’ fund in your pensions, which automatically move money into lower-risk assets in the ten years (TEN YEARS!) prior to retirement, then you need to seriously consider switching out in case you do irreparable damage to your chances of making your money last.
The reason those are set up is because most people used to buy annuity at retirement, which was a cash event. You’d hand over your money in return for a guaranteed income for life. Most people don’t do that now. You may still need to do some de-risking, but not wholesale.
Establish Your Cashflow Needs
Retirement is all about cashflow. Funny that, because so is the accumulation phase. If you were to ask me to distil how personal finance works to a single sentence or principle, it’s about managing money in and money out. That’s true when you’re saving up for your future, managing a mortgage, or drawing down off your SIPP.
Cashflow really is king. Good cashflow management is so far above every other aspect of financial planning, it makes things like asset allocation and fund choice look utterly insignificant in comparison.
When I’m planning with clients coming up to retirement, I spend time trying to help them establish their cashflow needs for the first five years of retirement. This informs just about every other decision when it comes to their finances, from how they should invest, to whether they should take their tax-free cash from their pensions and lots more besides.
So this is your first job. If you are heading toward retirement and you’re looking to set up your finances accordingly, the first thing you need to do is to plan your spending. This should be fun, right?!
Start with your basic monthly expenditure. What does it cost to run the household, to eat, to run one or two cars, to pay for birthdays and Christmas? No frills, just the basics of living – what does that cost? Write it down.
Next, what about leisure and luxury? These are the costs of things like club memberships, Netflix, regular holidays. Write these down too. Those two categories added together give us our desired lifestyle cost, which is a great start, but too often people forget to factor in milestone costs.
This is things like changing the car every x number of years, taking that big holiday when you retire with the whole family to a gite in France or to Center Parcs or whatever. Perhaps you have a family wedding coming up, or your daughter wants to take a Master’s degree and you want to help her.
Basic, leisure/luxury and milestone costs: you need to work out what these will be for the first five years of your retirement, and don’t forget to include inflation – your basic and your leisure costs will need to increase each year due to inflation. If you know what your ideal car costs now but you’re not going to buy it for five years, you’ll need to factor some inflation into that, too.
That done, you’ll need to understand your sources of income for the same period. This might be state pensions, DB pensions, rent from investment properties or whatever. You’ll know what they are and when they’ll come in. Only factor in known sources of income, not possible ones, like inheritances.
Don’t forget to factor in tax if any of your income sources aren’t taxed at source, or if you get statements that talk in gross terms. Tax is an expense you may need to factor in. If we know what’s going out and what’s coming in, we can work out the gap between the two and this is our cashflow need for the first five years of our retirement.
Err on the high side. Generally, clients spend more than they think when they retire, at least at first. It takes time for things to settle down to a new routine – the combination of more free time, good health (hopefully) and a decent investment balance makes for a heady mix. So maybe factor in a 20% contingency to your cashflow needs. Once we’ve established our cashflow needs, we can move on.
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