Monday, 21 March 2016

A simple, effective way to generate the income needed in retirement

One of the biggest challenges most people face in retirement is generating the regular income they need and maintaining it for the rest of their lives.

You may have substantial assets, but they're not limitless, so you must be careful how you manage them. To meet the dual goals of generating needed income and sustaining it this is what you do.
First, determine the amount of annual income you need currently—say, €50,000—and then determine the best place(s) to get it. It won't all come from your retirement account because you likely have other income sources: State benefits, perhaps a pension, an inheritance, earnings from a part-time job and funds from other savings or investments.

All of those could reduce dramatically the amount you need to generate annually—perhaps to as little as €25,000 or €30,000.

To determine the rate of return you need to earn on your investments in retirement, factor together all of these realities and your personal preferences: Do you want to leave something for your heirs, preserve capital or spend it down? Then it's time to design a portfolio to meet that target.
Once you have the right portfolio, what is the best way to invest it? Well, if diversification is important to use throughout your working career, as I have long espoused, then it's doubly important once you're in retirement.

A diversified portfolio, of course, contains some assets that don't generate income or dividends, along with others that produce those unpredictably, making it difficult to carry on your lifestyle.
That's solved by a systematic withdrawal plan. It's simple and effective and it works like this: You decline to pocket the interest and dividends from your investments, instead reinvesting them back into the portfolio. To compensate for giving up that income, you arrange to receive a similar monthly amount from your account.

There's a big difference between that and drawing the income that a portfolio produces, as many retirees opt to do. Here's an illustration: Say you had invested €100,000 in a one-year fixed interest bank deposit and received the annual interest each year from 2005 through 2015. The interest would have fluctuated wildly—from €700 to €4,210—and produced €19,520 in income over the 10 years. The original €100,000 remained unchanged.

However, if you instead created a diversified portfolio the account's value would have grown to €198,126. You could then start producing twice as much income and easily offset inflation.
You could have systematically withdrawn twice as much in annual income as the bank deposit, and your account value would still have been 74 percent higher than the banks value. Even if you took triple the income of the bank deposit, your account would still have ended nearly 40 percent higher than the bank deposit.

Simply matching, doubling or tripling the banks income, however, would have left you with inconsistent monthly and yearly amounts. To solve that problem, you could have arranged for a consistent monthly withdrawal, just as you get from Social Security or a pension.
If you took a 5 percent income stream from the starting capital you would have received €50,000 income and your ending value would still have been €158,680—or 58% more than what you started with.

Of course, my illustration is hypothetical over a specific time period. Different periods and asset mixes would produce different results and, as always, past performance does not guarantee future results but you get the idea. I recommend this as the best approach for generating the regular income you want/need to live on in retirement and sustaining it for your lifetime.

Friday, 4 March 2016

The importance of active management in emerging markets.

Investors in emerging markets would be well placed to take a discerning approach to both sector and country allocations in 2016 given current volatility and uncertainty.

The reality for emerging markets is one of a highly differentiated backdrop where opportunities do remain plentiful but only for those willing to be active in their asset allocations.

This generally means an underweight in financial services and significant overweight exposure to the healthcare and consumer sectors. Energy, materials, and industrials, likewise, are substantially underweight in an active strategy.

It’s not the emerging markets universe of 10 years ago where a rising tide was floating all boats – and that means you have to work all the harder to identify value and to avoid the risks. The index is one with significant commodity-related exposure which hides some very attractive growth opportunities.
In financials, the strategy’s sector allocation demonstrates this discriminating approach. Even though exposure to the sector overall is below that of the comparative index, holdings in life insurance companies are a key part of the portfolio, including through Hong Kong-headquartered insurance company AIA.

AIA and its UK-listed peer Prudential have product ranges targeted specifically at the Asian market and so have witnessed high rates of new business growth as countries in the region become wealthier and the number of middle class consumers has increased.

Even so, insurance penetration rates remain low and this means the scope for future growth remains high. In Indonesia, for example, the current life insurance market would be 64 times bigger than it is today if penetration rates were equivalent to those of the UK. By the same measure, China’s would be 31 times bigger.

On a country view, there is an element of misinterpretation about China’s growth prospects by the financial media as the economy rebalances away from commodities and primary industry and further towards consumption.

While there has been a decline in GDP growth, this has largely been caused by a deceleration in primary and secondary industries. Tertiary industry, by contrast, has performed far better, remaining more or less stable since 2012, albeit with a marginal decline.

Elsewhere, India offers opportunity after more than four years of pent-up demand during the economic slowdown preceding the election of prime minister Narendra Modi in May 2014.
The new government’s been doing the right thing and we’re beginning to see stronger growth coming through. The country benefits from positive demographics, and low credit penetration and that helps underline the investment case even as far as the potential for growth in things like car ownership.
Finally, consider the power of demographics to drive future growth, most significantly through changes in the working age population. According to UN estimates, the likes of Malaysia, the Philippines, Peru and India are forecast to see significant GDP tailwinds between 2011 and 2035 as their working age populations grow.

In contrast, developed countries such as Japan and Germany are expected to see sharp declines in the number of people in work over the same period – and this will likely create a drag on GDP growth. In terms of their productivity potential, emerging market countries are generally in a superior position versus their developed market peers.

But even here, a discriminating approach is important, he says, noting that Russia, Korea and Thailand – all of which sit in the emerging markets universe – are expected to experience a decline in their working age populations of between 10-15% between 2011 and 2015.

It underlines the point that not all emerging markets are the same and that active management is the key. As always, consider opting for high quality investments with a focus on income producing assets and seek advice where appropriate.