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What is Longevity Risk?

Running out of money in retirement and existing on the age pension alone is not most people’s idea of a comfortable retirement. But longevity risk – the risk of outliving your savings – is looming as a greater risk than investment risk.

Markets recover eventually but the period of time that needs to be funded in retirement is ever-growing.

While people who have seen their portfolios savaged by the Global Financial Crisis may be tempted to put money in a term deposit or cash management account, this may only be appropriate for at best up to two years. The returns supplied by such investments are generally too low to justify longer investment periods.

We are all living longer…

The Australian Bureau of Statistics says the number of people aged 85 years or older is projected to grow from 334,000 in 2007 to 1.7 million in 2056, meaning there is a 50% chance that half of today’s 65-year-old self-funded retirees will live beyond 90.

In the accumulation (pre-retirement) stage, investors building towards their retirement generally require reasonable exposure to growth assets. These assets however remain an option in retirement, as if you are going to live another 20 or 30 years you may need growth to offset the impact of inflation and a potentially diminishing asset base.

… So plan for it.

While there is no single, correct answer to asset diversification in retirement, people need to understand where they are invested and the associated risks to allow appropriate decisions. Investing should be kept as simple and as transparent as possible, if retirees do not understand how an investment works, the answer is often “then don’t touch it”.

The traditional approach to managing longevity risk is a class of life insurance products called lifetime annuities. These have not been popular with retirees in recent years because traditional annuities may leave no capital for the estate and pay low interest rates.

Recent years have seen an increase in the popularity of investments that offer capital protection, with the likelihood being more of these products will come into the market in the future. While the guarantees fulfill a need they will not suit all retirees because the guarantee, whether income or capital, has to be paid for through higher fees.

If we have learned anything from the Global Financial Crisis it is that being aware of all implications relating to an investment or strategy is vital, too many investors and project promoters would have you only consider the upside, but of course there is far more to take into account. The potential for short or long term loss must be factored in, and even capital guaranteed investments while comparatively safe, may not allow you to meet your long term retirement income goals.

Where to from here?

If you approaching retirement and remain unsure of what your future holds you may benefit from a chat with a financial planner to address your own financial situation and long term goals.

Remember: We all have ideas and goals for our retirement, with a little professional help and some sensible planning these ideas and goals are more likely to become reality.

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