Retirement and the uncertain timing of death

If there's one thing we can be sure about in life, it's death. And it's fair to say that it would make retirement planning a whole lot easier if we could see into the future. However, without a crystal ball, we have to come up with a plan. Many financial plans are based on average life expectancy. But this isn't a good move. Read on to find out why.

The problem with average life expectancy

In Australia, the average life expectancy of a female is about 85. Which means that some will live past this age, while others won't. Therefore, planning your retirement using average life expectancy is a poor predictor of your actual lifespan. Realistically, it will only work for a small number of people. The majority need a plan that will fund them right into their 90s – perhaps even beyond.

Prepare to live past your average age.

With people living longer lives, you need to be prepared - unless you have ill health or can expect a shorter lifespan because of family genetics. If you don't plan for living past your average age, you may not have enough money to fund your living costs and capital expenses in the future. And that's one of the interesting things about investing for your retirement. Most people focus on the risk of losing their investment capital either temporarily or permanently. What they overlook is that they may spend it all too soon.

Couples and increased life expectancy

Planning for retirement using average life expectancies can have a real impact on a couple. 70% of people enter retirement with a partner, which pushes their life expectancy even higher than for an individual. That means your partner may live even longer than the average life expectancy for their gender. Which just goes to show how crucial it is for you to plan as if you'll be alive and well at 100.

The wealthy live longer.

Many people own their homes long before retirement and have a higher-than-average super balance. All the same, you may not see yourself as wealthy. However, if you're considering your finances and have a financial planner on board, you're likely to live longer than someone not as educated. On top of that, feeling secure about your future contributes to better health and less stress in your later years, which can increase longevity.

Equity market returns and longevity

Whatever the size of your investment portfolio, you need a plan that makes sure your money is working for you into the future. The uncertainty around life expectancy is significant. Most investors are aware that equity markets can be volatile. What they probably don’t realise is that the variation around life expectancy is about the same as 10-year equity market returns. For a retiree, the uncertainty around how long they will live is as big as the uncertainty around average real Australian equity returns over successive 10-year periods from 1900 to 1910 and so on through to 2010 (based on Morningstar data). Equity markets and growth assets generally have the ability over the long-term to generate returns that can help offset the risk that longevity poses.

Short term risk. Long term gain.

If you feel comfortable investing part of your capital into assets that will grow over time, the Clearwater Dynamic Portfolio allocates 90% to growth assets. You'll experience more volatility, but over the long-term, you'll experience higher returns. The challenge is to find the balance between growth and defensive assets that work for you and can support you throughout your life.

An increased level of protection

Our DMG Diversified Portfolio has demonstrated the ability to offer a good level of protection when growth assets fall. Over the long-term, it does give up some of the higher returns by reducing risk. The asset allocation is currently around 70% growth assets and 30% defensive assets. But this will vary as the investment committee sees fit - always adjusting the allocation to help protect your investment.

Creating certainty out of uncertainty.

At the end of the day, when you're mapping out how to fund your retirement, the average life expectancy model could leave you short. Investing in the financial markets is a smarter way to ensure you're on track to enjoy higher returns well into the future. That way, you can rest assured that neither you nor your partner, will have to rely solely on the age pension in your twilight years and you'll have enough money to see you through.

by Gary Lucas.