Question

I will be retiring at the end of June and I am horrified by what has happened to my retirement funds. They have dropped significantly since the beginning of the year. What do I do?

Answer

Your anxiety is understandable. Retiring into a falling market is a real financial problem.

There are two things that you must bear in mind:

1. markets do recover quite quickly after dramatic falls like the one we are experiencing.
2. Retirement is not a single event. It is a journey that may last 35 years.

The real question is, “How do I stop a temporary market fall from permanently damaging the rest of my retirement?”

If you are retiring at the end of June, I would set aside up to six months of the income that you need into a money market fund or a similar low-volatility investment.  This will give you a bit of breathing room and enable you to make better decisions.

There are two big risks  that can derail a retirement income plan. These are sequence risk and longevity risk. Let’s deal with them one at a time.

Sequence risk

Sequence risk is the danger of poor market returns just before or just after you retire. That is exactly the kind of environment many retirees are facing now.

This is such an important risk because, once you retire, you are no longer putting money into your investments. Instead, you are drawing from them to pay for your living expenses.

If markets fall while you are taking an income, you may have to sell investments at depressed prices. That means less capital remains invested when markets recover, and less capital is available to support your income in future. This is why poor returns early in retirement can be far more damaging than poor returns later on. A weak start can affect the rest of the journey.

It is therefore important to structure your retirement portfolios correctly  and choose the right investment components

One way to help manage this risk is through smooth growth funds. These funds typically hold back part of the strong returns earned in good years and use those reserves to support returns when markets are under pressure. The goal is to make the investment journey steadier and reduce the impact of short-term market swings.

Given how strong markets have been over the past two years, many of these funds may currently have healthy reserves. It may therefore be worth considering whether some exposure to this type of strategy could help reduce sequence risk in your portfolio.

Longevity risk

Longevity risk is the risk of living longer than your money lasts.

People are living longer, which means your retirement capital may need to provide an income for 35 years.

 When you retire into a market like the  one we are experiencing,  the natural temptation is to move your money into a very cautious portfolio. That may make you feel better now, but it can create serious problems later.

The reason is that your investments still need to grow faster than inflation. Retirement inflation is often higher than normal inflation, particularly because older people tend to spend more on medical costs and other essentials. If your portfolio is too cautious, it may not grow enough to protect your standard of living over time.

This is the central tension in retirement planning. You need capital protection, but you also need capital growth.  You need growth assets in the portfolio to produce decent long-term returns, capital has to be managed carefully and protected as far as possible.

In practice, that often means combining different assets and strategies that behave differently in different market conditions. The objective is not to chase the highest possible return. It is to improve the chances that your income can be sustained through many different market cycles.

To do this, you need to look at using financial structures like

• Income funds
• Smooth growth funds
• Moderate and aggressive equity funds
• Hedge funds

Used correctly, these structures can help you achieve three things at once:

• give you enough stability to deal with the current market weakness
• reduce the risk of having to sell assets at the wrong time
• keep enough long-term growth in the portfolio to help your income beat inflation over the years ahead.

Retirement is full of moving parts, and getting the balance right matters enormously. That is why I would strongly recommend speaking to a good financial planner who can help you put the right structure in place. A weak market at the point of retirement is unsettling, but it does not have to define the rest of your retirement if your income and investments are structured properly from the start.