Janine Starks (independent columnist and my business partner in Liontamer Investments) wrote an Agony Aunt article in the Press and the Dominion Post in 2014, in answer to a question from a 60-year-old couple considering early retirement, as to whether their savings would allow them to live on $70,000 a year until the age of 85. By investing their capital in a term deposit, they hoped to achieve their goals. We discussed the use of my retirement model, which she aptly described as the “retire-o-meter”. I updated the original comparison in her article and my book Legal Tender to reflect the lower deposit rates currently on offer by the banks.
The question was not just whether the couple could achieve their retirement income goal of $70,000 a year, but whether it could be done with inflation proofing. Today’s $70,000 would need to be more like $115,000 in 25 years to maintain its purchasing power.
For the first five years, withdrawals needed to come solely from their portfolio. New Zealand Superannuation only kicks in at age 65, with around $30,000 a year for a couple, after tax. They own their own home and have savings of $1,000,000, plus KiwiSaver funds of $200,000. As a lifestyle asset, their home cannot be included in the goal portfolio, unless they sell and downsize or rent. KiwiSaver rules delay access to their money for another five years. So the initial capital dedicated to their retirement goal is $1,000,000. Modelling showed that at three per cent real growth (after tax and inflation), their KiwiSaver balance would grow to $247,000 with an annual $1,000 contribution to get the tax credits. This sum was added to their goal portfolio after five years.
Term deposits scenario
For the term deposits, a real return of 0.5 per cent (after tax and inflation) was used (although this sounds low, it is a reality that tax and inflation eat away at your return especially with term deposit rates around 3%). A volatility of 0.4 per cent was assumed for the term deposit return, since interest rates go up and down, but less so than the return on equities or a balanced portfolio.
Balanced portfolio scenario
For the balanced portfolio (a combination of 50 per cent growth and 50 percent income assets), a four per cent return was assumed (after tax and inflation but before fees). It was assumed this could vary between -8 per cent and +16 per cent, with a 95 per cent probability (which is greater or more conservative than the 68 per cent confidence level mentioned earlier).
The “retire-o-meter” was then run for each scenario using the above inputs, looking for outcomes that could be achieved with 75 per cent probability or higher.
With 25 years of regular withdrawals, the couple can be fairly confident of being able to spend $90,000 (in real terms) a year with a balanced portfolio, and $76,000 with term deposits at current rates. Both options would leave no legacy at the end.
What we can conclude from this comparison is that although the term deposits scenario is likely to achieve the goal of a lifestyle of $70,000 a year in retirement even in the current low-interest rate environment, the couple could significantly improve their retirement income or protect themselves from longevity risk if they included growth assets in their portfolio. With a lifestyle of $70,000 a year, a balanced portfolio would see them through until the age of 100 compared with 89 in the term deposits scenario. If they wanted to maximise their lifestyle and didn’t expect to live beyond 85, they could live on $90,000 a year (including NZ Superannuation) compared with $76,000 in the term deposits scenario. That is a significant improvement of $14,000 a year or $538 a fortnight.
The role of the financial adviser is to empower clients to make informed decisions which could make a significant impact on the quality of their retirement. A framework within which to make informed decisions gives tremendous peace of mind.