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Longevity risk: Death of retirement?

Intelligent Investor

By Kalinga Kulatunga

(March 28, Sydney, Sri Lanka Guardian) Face it, retirement is not a great idea, especially at 55. Retirement is one of those words in English that will soon be delegated to history. Retirement as we know it today is a relic from a time and a world that has long since passed. The concept of retirement was a short-sighted political tool, employed in nineteenth century Germany, which grappled with widespread unemployment.

In fact, when the original retirement age was planned and set at 62, the average life expectancy was 63! This was a clever way of solving the unemployment situation and not paying any social security benefits, at the same time.

Sri Lanka, like the rest of the world is about to enter a decade where a significant number of the most experienced workers head for so called “retirement” in droves. For many companies this loss will be irreplaceable. Worst still, many will be retiring at a time when they are extremely fit to produce exceptional results. A look at the birth rates and outward migration also indicate a serious shortage of younger people who can take up these senior roles.

However, it is financial security that may kill retirement altogether. Low interest rates, rising prices of goods and services and longer life spans have made retirement income calculation all the more harder. Low interest rates also pose a grave risk to retirement income as discussed at length in a previous column.

There is very little effort put into understanding the true cost of living for retirees. Everyone assumes inflation as reported by the consumer price index or CPI is representative for all members of society. This is a major mistake when it comes to retirees. The kind of goods and services (increased health care and almost no spending on education) that a senior citizen purchase, are very different to those of a young family. Health care in particular has grown at double the rate of inflation over the last 20 years.

While living longer on less is bad enough, the smartest wizards from around the world are yet to find a way of guaranteeing a decent income for self-funded retirees.

This is a major dilemma for millions of Sri Lankans who work in the private sector, where the EPF/ETF contributions are defensively managed with the bulk invested in nominal government bonds. In reality, this investment return would not even keep up with the rate of inflation, thus providing a lump-sum from which it’s hard to derive a decent income.

Longevity risk (people living longer than once assumed) needs to be addressed at the government policy level in order to avoid an impending disaster. Allowing workers to retire at 55, and guaranteeing a pension for a further 20 to 30 years is unaffordabe. Thus the government will face one of two stark choices which will have a direct impact on all individuals; raise taxes or raise the retirement age. Neither are attractive propositions. The decision as with all policy decisions anywhere in the world will be taken in light of political considerations. It will also pit government workers with a guaranteed pension (albeit a measly one) against the private sector who have no cover whatsoever.

As most policy decisions are beyond the control of the average citizen, it leaves only a limited number of options at the discretion of individuals who wish to have a decent income in the latter stages of life.

First, don’t count on any single investment to provide for your total needs once you stop working. Long term market data shows that the final return to investors from most strategies tend to be in the -0.2% to 4% range, net of all expenses. While some investment strategies are sensible, don’t bet your house on the final outcomes. Diversifying your assets across a range of different investments offers the best defence.

While bank deposits seem to provide a constant stream of income, the safety accorded there is a mere illusion. In reality, you lose the value of your capital over time to inflation. Any sound retirement plan should thus have some exposure to growth assets which provide some income, while recognising the potential for significant volatility along the way.

The average retiree is asset rich, but cash-flow poor. They own property, and homes worth millions, but struggle with day to day expenses. The challenge here is to create effective and durable income streams from these assets, in advance of the final retirement date.

But the new reality may well be for both employers and employees to prepare themselves for part-time work. This serves the employer by shoring up invaluable experience within the firm, and employees continue to make an income, thereby offsetting further to the future when they have to drawdown their life savings.

(The writer is an Investment Specialist based in Sydney, Australia. He can be contacted via kajangak@gmail.com ).

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