Pensioners tend to struggle in a low interest-rate environment. What investment decisions should they be making?
Investors have endured continuously falling short-term interest rates, which are now reaching 30-year-lows. This begs the question as to what pensioners should do with their investments in the fixed interest domain, given the current environment.
Pensioners are understandably not in favour of rate cuts. Many depend on interest as their source of monthly income, so lower interest rates mean less money.
Their income-generating years are behind them—unless they find a lucrative hobby—so investment becomes fraught. On the one hand, they want liquidity. Will they be able to get hold of their money if they need it?
On the other, they tend to avoid risk and are afraid to exhaust their capital. And when interest rates go down, they see their income eroded.
Financial advisers agree that pensioners tend to seek low-risk investment options, but they don’t always agree on which options will produce the best long-term yield.
Paul Hutchinson, head of Cadiz Collective Investments, believes that pensioners should consider taking on more risk than they might ordinarily be comfortable with, or be forced to downgrade their lifestyle in the future. “Lower-risk asset classes may not always be the way to go,” said Hutchinson.
“Yes, a fixed deposit or money-market account may offer some liquidity and relative certainty of income, but low-risk assets don’t necessarily outperform inflation.”
On an after-cost basis, investors in money-market funds, for example, are now likely to only receive returns of about 6% (and lower after tax, depending on each individual’s marginal tax rate).
These returns are minimal and unlikely to provide sustainable income. Hutchinson recommends that pensioners consider migrating some of the low-yielding investments to at least flexible fixed-interest funds that have a broader investment opportunity set and are likely to deliver a higher yield over time.
Options to consider
A few years ago, the yield curve was “inverse” and money-market rates were higher than bond rates, but now that short-term rates are lower than longer-term interest rates it makes sense to move to an income fund which can invest in longer-dated fixed-interest instruments.
Some income funds are expected to yield a gross return of about 8% over the next year, since an interest-rate hike seems unlikely in the medium term—in fact, the interest rate is expected to move sideways.
The bond market remains somewhat volatile, though government retail bonds look like a good bet. Victor Mphaphuli, a portfolio manager at Stanlib Asset Management, suggests that government retail bonds are ideal for pensioners because they offer a good return (about 8,5%, which outperforms inflation by a good margin) and are generally low-risk to capital.
The interest rate paid is a fixed percentage and when they mature (whether in one year or 10) you will receive the full capital invested. Although your capital does not really grow, this is a low-risk option for generating income. But you can’t withdraw your initial capital until the bond matures, which has an impact on continuous liquidity drawdowns that pensioners typically need.
“Over and above moving investments up the yield curve into income funds you could, for example, look at a two-year bond with a one-year extension,” Mphaphuli suggests. “In this way, you are not risking default, and your capital remains secure.”
Hutchinson recommends that pensioners also consider some exposure to equities, though with the assistance of a financial adviser, given that they can be volatile.
Exposure in asset-allocation type funds may well be preferable, despite the capital and income risks which these portfolios are subject to.
Pensioners typically use money paid out of a retirement annuity or a pension or provident fund to purchase living or life annuities.
Life or fixed annuities guarantee a predetermined payout for the duration of your life while living annuities depend upon the investment performance of the underlying assets.
Pensioners do need to be aware that the return on capital in a living annuity may not be high enough to provide a sustainable income for life, though, so the type of annuity has to be thoroughly investigated, as does the risk/return ratio.
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