Retirement Plans and Priorities
Investing for retirement requires a long-term perspective and clear goals
S. Katherine Roy
- It may be difficult to prioritize retirement planning, but the sooner a plan is established, the more successful it can be.
- Retirement planning presents a particular challenge in Asia, where populations are rapidly aging, birth rates are plummeting and established government pension systems will likely fall short of meeting most lifestyle needs. Facing the challenge will require individuals to think about—and invest for—retirement with a long-term, goal-oriented perspective.
- The first step in retirement planning: identifying which factors one can control (savings rate, portfolio risk) and which factors are out of one’s control (market returns).
- A strong savings rate is important, but capital must be put to good use. Portfolio diversification is especially critical. The considerable benefits of saving early will be eroded when a portfolio is invested in cash instead of a balanced mix of asset classes.
- A retirement strategy will optimally address two very different life stages. In the first, accumulation, it is important to invest with a healthy growth target, given one’s risk capacity. In the second stage, decumulation, the chief goal is to generate income based on a “safe withdrawal” target.
IT IS NOT EASY TO MAKE RETIREMENT PLANNING A PRIORITY WHEN OTHER FINANCIAL GOALS—BUYING A FIRST HOME , FOR EXAMPLE , OR SAVING FOR A CHILD’S EDUCATION—APPEAR MORE PRESSING. BUT THE SOONER A PLAN IS PUT IN PLACE, THE MORE EFFECTIVE IT CAN BE.
That basic principle has particular resonance across many Asian societies, where populations are rapidly aging and established government pension systems may not be able to meet the majority of lifestyle needs. Exacerbating the situation are plummeting birth rates, even as parents earn higher incomes and look to spend more on their children than previous generations have done. The demographic shift is part of larger structural changes in Asian economies. For decades a huge labor pool of young workers helped fuel strong economic growth; today many of those workers have either retired or will soon leave the workforce.
All of which is to say that retirement planning presents a real challenge to Asian individuals, families, corporations and governments. Meeting that challenge will take time, energy and focus. Most of all, it will demand that individuals think about—and invest for—retirement with a long-term, goaloriented perspective. In the following pages we present our keys to achieving a successful retirement outcome. At a high level we address the following subjects:
- The importance of a retirement plan
- Sources of retirement income
- Wealth allocations optimized for successful retirement outcomes
- Life stages of a retirement plan: accumulation and decumulation
IMPORTANCE OF A RETIREMENT PLAN
Populations will get significantly older by 2050
EXHIBIT 1: PERCENT OF POPULATION OVER 65
Across many Asian societies, people are living longer (EXHIBIT 1). At the same time, birth rates are plunging. As a result, the old age dependency ratio (the ratio of over 65-yearolds to workers ages 15–64) is on the rise, while the ratio of under-15-year-olds to workers ages 15-64 is declining. For example, in 1975 33% of the Singapore population was age 0–14. By 2050 it will be only 14%, while the 65 and older population will increase from 4% to 29% in the same time period. 1 And by 2050, in Hong Kong, Taiwan and Singapore, 25% of the population will be over 65 years old. Aging populations add significantly to the burden of providing adequate retirement and health benefits. Further complicating the picture, the cost of living is increasing at an accelerating rate relative to wages. Clearly, there is a need for greater funding for retirement.
To reach that important goal, traditional approaches to retirement need to be amplified. One element of a strong foundation for retirement security is already in place: a strong savings culture (in Hong Kong, for example, people save 20% of income). But such high savings rates may prove difficult to sustain as living costs continue to rise. Another element of the traditional approach is family support: in many Asian cultures it has been widely assumed that grown children will take care of their aged parents. Although filial obligation remains an essential part of the social fabric, many are questioning if it can be relied upon as it has in the past, given the increasing ratio of parents and grandparents to working children. Shifts in culture and society will likely cause further changes in this long-entrenched tradition.
SOURCES OF RETIREMENT INCOME
National pensions can provide only a portion of income needs in retirement
EXHIBIT 2: REPLACEMENT INCOME NEEDS IN RETIREMENT IN HKD*
Governments are well aware of the retirement challenge and many have begun to take steps to bolster retirement security by implementing mandatory savings programs. The savings rates in these programs differ from country to country. The Mandatory Provident Fund in Hong Kong requires a 10% savings contribution, split evenly between employee and employer (employees earning less than $7,100/month are not required to make a contribution). On the other hand, the Central Provident Fund in Singapore mandates a 37% savings contribution from employees age 50 and younger (the employee contributes 20% and the employer 17%). Although these programs will make a real contribution to strengthening retirement security, they will likely be unable to meet a majority of lifestyle needs (EXHIBIT 2).
Another problem is that governments are encumbered by rising health care costs, a growing problem as populations continue to age. Health care costs will account for 27% of the total budget in Hong Kong by 2033. 2 As government budgets are increasingly stretched, it places an even greater burden on individuals to plan and save for their retirement.
OPTIMIZING WEALTH ALLOCATIONS: SAVING IS NOT ENOUGH
Some factors are entirely or partially within one’s control; others are completely out of one’s control
EXHIBIT 3: THE RETIREMENT EQUATION
The first step in that process: identifying which factors an individual can completely or partially control and which factors are out of one’s control (EXHIBIT 3).
As the exhibit illustrates, an individual’s savings rate and portfolio risk are two factors that are entirely within one’s control. Savings rates are high across Asia, as we’ve noted. But much of this savings is maintained for precautionary reasons rather than being invested to achieve a particular goal. Unless this capital is invested more productively, taking appropriate and calculated risks to meet retirement goals, the benefits of strong savings cannot be fully realized. In many Asian societies, there is considerable room for improvement in both asset allocation and the management of portfolio risk.
Well-diversified portfolios allow a balance between risk and return. Indeed, effective diversification may provide better returns with less risk, resulting in a smoother ride over the long term. Putting retirement investments into too few asset types can expose an investor to large declines if one of those asset types experiences episodes of volatility. As recent bouts of market volatility remind us, these periods are often unpredictable.
Across Asian societies, cash plays an outsized role in household financial assets
EXHIBIT 4A: HOUSEHOLD FINANCIAL ASSET ALLOCATION BY COUNTRY
Hong Kong data are based on Stock Investor Survey (2006) by the Hong Kong Securities and Futures Commission, insurance is included in Other and pension is not included due to data availability. Equities and fixed income in total made up of 15% of Singapore households’ financial assets, simple 50/50 is taken for illustration purposes. Total may not sum to 100% due to rounding.
EXHIBIT 4B: AVERAGE ANNUAL REAL DEPOSIT RATE BASED ON RESPECTIVE COUNTRY’S DEPOSIT RATE LESS YEAR-OVER-YEAR INFLATION*
Yet in many Asian countries, retirement portfolios are inadequately diversified. Often, much of household wealth is held in real estate. In Singapore, for example, about 55% of household net worth is held in residential property.3 And in their financial asset allocation, households hold far too much in cash. In Taiwan, cash and bank deposits account for 42% of household financial assets, and in Hong Kong, 45% (EXHIBIT 4). (In the U.S., in contrast, the percentage is just 14%.) Individuals need greater options for income in retirement than can be provided by real estate and cash.
Investors should save early and often for retirement, harnessing the power of appropriate portfolio diversification
EXHIBIT 5: BENEFIT OF SAVING EARLY
Indeed, the damaging effects of excess allocation to cash cannot be overstated. As EXHIBIT 5 illustrates, the considerable benefits of saving early will be eroded when a portfolio is invested in cash instead of a well-diversified mix of asset classes.
LIFE STAGES: ACCUMULATION AND DECUMULATION
Whatever retirement strategy an individual chooses, it should be informed by a long-term focus. Put another way, anyone planning for retirement in, say, more than a decade, should know that time is on his side. Even someone who is generally risk-averse should assess his capacity for taking on some level of risk. This recommendation is especially relevant in Asia, where financial crises in 1997 and 2008 have left many excessively leery of taking on any financial risk at all.
A retirement strategy must address two life stages, accumulation and decumulation. In the first, which runs from the first day on the first job until retirement approaches, assets are accumulated. During this period, it is critical that an individual take the long view and invest in a well-diversified portfolio with a healthy growth target, given one’s risk capacity. Time, as we said, is an ally.
It is also important to balance multiple savings goals. Even as a parent sets aside a portion of a paycheck for his child’s educational fund, he can’t give short shrift to the need for long-term retirement saving. The best course is to dedicate separate pools of savings for each specific long-term goal (such as buying a house, financing a child’s education or funding a couple’s retirement).
In the decumulation phase, the investment approach is quite different. During this period, the chief goal is to generate income based on a “safe withdrawal” target. (This refers to a withdrawal rate from a retirement portfolio that would prevent a retiree from outliving his money.) Caution is key in the decumulation phase because an investor must be prepared for an extended period of poor market returns. There is also potential risk in investing too conservatively or withdrawing too aggressively, as either approach may increase the risk that a retiree will eventually run out of money.
CONCLUSION: SET PRIORITIES, MAKE A PLAN
Retirement planning can be daunting, but it can also draw on a powerful advantage—a long time horizon. Even relatively modest savings, if invested sensibly in a well-diversified portfolio, can deliver the desired investment objective down the road. An experienced financial advisor will be able to help an individual establish goals, assess risk capacity and determine appropriate asset allocation and investment strategies. The key, at any age or life juncture, is to make retirement planning a priority.
For additional information, please contact your J.P. Morgan representative.
Women expect to save 29% less for retirement than men, and face a bigger shortfall than male investors.
Women would need 25% more money than what they expect to have saved to maintain their current lifestyle through retirement, compared with a 14% shortfall for men.
Women are expected to spend eight years longer in retirement than men because they are expected to live 6 years longer (women’s average life expectancy is 87 years4 compared with 81 for men); and they also hope to retire at 61, two years earlier than men.
Overall, their smaller retirement nest egg will need to be stretched over a longer retired life, exposing them to higher risk of outliving their savings.
Ironically, female investors are less willing to take on risk to grow their portfolios. Our survey found women tended to be more cautious with investing for retirement, with only 70% investing in stocks compared with 93% of men, and 56% investing in mutual funds (71% of men). This could curb their chances of accumulating sufficient wealth to achieve their retirement goals.
We recommend that women use the longer time horizon that they have to their advantage, and make their money work harder for them.
WE RECOMMEND A “FIGHT” PLAN …
While the previous statistics may seem daunting, it is important to recognize that investors do have control over how much they save and how they invest.
We found in our survey that only 20% of investors feel confident enough to know how much they need to maintain their lifestyle in retirement even though they have a ballpark number in mind.
A good starting point is to reference the checkpoints in our Principles for a successful retirement. It provides a gauge of how much you need to maintain your current lifestyle based on your age and household income. With this as an initial guide, you can further personalise your goal based on your lifestyle and when you want to retire. As you map out how to accomplish your goal, assess if your current saving and investing behaviour will allow you to achieve your goal and the changes you may need to make. Be sure to review and update your plan over time as your circumstances change.
Once a plan is in place, it is important to “fight” by getting invested early and regularly, as well as diversify and adjust over time as the time horizon changes.
1) Start early and invest regularly: Starting to invest early allows you to take advantage of the power of compounding and can help you achieve your long-term goal at a lower cost, as illustrated in Exhibit 2. Consistent Chloe, who started investing early, ends up with nearly double the amount of Late Lyla, who started only 10 years later. Nervous Noah saves as much and as often as Chloe, but chooses not to invest his money, so he only manages to accumulate less than half of Chloe’s final amount at 65. Saving early and regularly, and investing what you save, are some of the keys to a successful retirement due to the power of compounding over the long term.
Harnessing the power of compounding can help achieve long-term goals at a lower cost
Exhibit 2: Account growth of HKD 12,000 invested/saved annually
Starting early also helps you build the habit of investing regularly, which allows you to reap various benefits. Investing regularly....
a) Provides discipline/helps avoid emotions interfering with investing decisions: It is often tempting to try to “time the market” by buying low and selling high. It rarely works, even for the savviest professionals. History shows that investors tend to follow the herd. When prices are rising, their confidence grows as the bull market matures. By the time they drum up the courage to enter the market, it is usually at market peaks, especially right before a crash. By then, they have missed all the growth opportunities and have to bear with the decline. On the flip side, when prices are falling, they sell out of panic just before a recovery is about to begin. In other words, investors tend to buy high and sell low. These ill-timed moves are usually driven by emotions. While emotions can’t be eliminated, they can be tamed if you take a disciplined approach of investing regularly. Take a step back and think about it — investing into a falling market is where the best investments are made because the prices are low. But this takes courage. To guarantee that you will buy throughout varying market cycles is to invest regularly, to capture opportunities at times when emotion might inhibit getting invested.
b) Averages out costs: A consistent savings amount is being invested periodically regardless of net asset value and market level. This means that investors will buy more shares when prices are low and buy fewer shares when prices are higher. The result is averaging out of the cost and spreading out the risk. In fact, history suggests that no matter at what market level you start investing regularly, the longer you stay invested the higher the probability of a positive return (as shown in Exhibit 3 below). So, by investing regularly you do not have to worry about deciding “when” to invest — this can help reduce the mental burden.
c) Enables you to pay your future-self first: There are many platforms that can help you set up a regular investment plan; one example is J.P. Morgan’s eTrading platform. The platform can automatically help you invest a fixed amount regularly on a fixed date of the month. This way you do not need to think about it or take any actions. At the same time, you won’t forget. And because you are paying your future-self first, you won’t inadvertently use the money for other purposes.
Diversifying and staying invested can provide higher probability of positive returns
Exhibit 3: % of historical positive annualized IRR between 1947 and 2018
2) Diversify and staying invested: To tame your “flight” instinct, being diversified and staying invested for the long term is key, as it can provide smoother returns over varying market cycles. This is a sensible way to batten down the hatches against volatility and avoid emotional investing errors like selling the market at the bottom.
In Exhibit 3 on the previous page, the diversified 50% equities and 50% bonds portfolio has a higher probability of achieving positive returns, compared to pure stock or bond investments. And this probability rises the longer you stay invested. This means that even though the market may have a bad day, month or year, if you diversify and stay invested over a longer term, you have time to weather market volatility and earn a solid return.
Seek advice from an asset manager with a long-term view and global reach to help you build a well-diversified portfolio that matches your needs.
3) Adjust your allocation as your time horizon changes: At diferent points in life, investors have diferent needs and face diferent risks (Exhibit 4). In general, we see three distinct life phases:
- When you are young, because markets tend to produce positive returns over the long term, time is your friend. The longer you leave your money invested, the more compound returns will grow your portfolio. As you have risk capacity, you can allocate more to equities to participate in market growth.
- When you approach your 40s-50s, your time horizon becomes shorter. Your financial commitments to the family may have increased significantly. And savings become more uncertain. At this point, it is important to dial back risk. Shift to a more conservative strategy to protect the wealth you have accumulated while still seeking some growth during your remaining working years.
- In retirement, you may worry about having a stable income, so it is important to dial back risk even more. But at the same time, you may be worried about the possibility of living to 100 or beyond. You need to make sure your portfolio grows and generates stable return at the same time.
It is important to understand the appropriate level of risk for your retirement savings, based on balancing your risk tolerance with your time horizons (aka risk capacity). Try not to let your emotions get the best of you and flee the market in times of turbulence.
Remember to stay focused on the appropriate level of risk for your life stage. Dynamically adjust your investment based on your time horizon but don’t let short-term volatility derail your long-term retirement goal.
Adjust allocation over time for better retirement outcome
Exhibit 4: Portfolio framework
Retirement is a long-term goal. Instead of succumbing to your “flight” instinct and letting short-term volatility derail your financial future, as observed in our survey, you would be better served to take a “fight” response.
“Fight” by focusing on what can be controlled: saving and asset allocation. Start early and invest regularly to reap the benefit of compounding assets, and to help you keep pace with inflation. Besides, diversifying and staying invested can provide better risk-adjusted returns with lower volatility over time.
Finally, be thoughtful of your investment horizon and dynamically adjust your portfolio as you move into diferent phases of your life.
Seek advice from an active manager with a long-term view and global reach to help you achieve your retirement goals.
For additional information, please contact your J.P. Morgan representative.