I guess some might respond ‘yes’, some will respond ‘no’ but most will respond ‘don’t know’ or ‘only wish I knew’. But knowing to the best of your ability is important and it becomes more critical the closer you get to retirement age.
Before assessing the prospects we have to consider two key questions:
- How long can you expect to live?
- What provision have you made to provide income in retirement?
Let’s take the first: how long can you expect to live?
A first guideline would be statistics based solely on nationality. The following are recent life expectancy figures at birth for a sample of nationalities:
United Kingdom: 81
But this is just the starting point. As you get older your life expectancy rises also. If you reach 99 the new number could be 102. But the actuaries working for insurance companies will factor in other data such as where you live, race, family history, medical conditions, weight, smoker or non-smoker, drinking habits, lifestyle etc. Now supported by massive computer power, they can probably tell you the precise day you can expect to die. But don’t mark it in your diary yet! The statistics apply to Mr. or Mrs. Average and are based on moving projections which even you can help change to a degree.
Mortality predictions are of critical importance to life insurance companies as they have to offer competitive products but still ensure they make a profit. What is a little scary is that Artificial Intelligence is taking over some of the tasks of the actuaries. Consequently some people could find themselves ineligible for insurance cover or find their premiums are heavily loaded based solely on what the computer tells the insurance company.
They say that perfect financial planning entails spending your money frugally in retirement so that it runs out on the day you die and your cheque to the undertaker bounces. That’s a little hard on undertakers but it’s also going to be tough for you the next day if the predictions are wrong and you are still alive but with no more money!
What is the next step?
Clearly you need to make some allowance for the possibility that you are going to live a lot longer than Mr. or Mrs. Average. So now you need to calculate how much you are going to need.
If you own the home you live in you may no longer have a mortgage to pay off but don’t overlook the other costs that come with home ownership such as local taxes, utilities, maintenance, repairs etc. And all these costs are likely to rise. If you do not own a property you are going to have to estimate rental costs, another item that will escalate over the years.
You then need to calculate all the items you will need at today’s prices. The items will include food, clothing, medical care, transport, entertainment, travel, visa and related costs if you are an expat, media and communications etc., etc.
Will your income hold up?
Now you have digested the bad news, you need to add together all the sources of income you expect to receive upon retirement. They may include state, company or personal pensions or annuities, income from financial investments, property rentals, interest on deposits etc.
Will they be sufficient to match the outgoings you have calculated? And will income from those sources increase in line with inflation? Only by doing the arithmetic will you be able to make an initial assessment.
Inflation is the big threat to those on a fixed income
For the past few years most countries have enjoyed fairly benign inflation and low interest rates. But the signs are that inflation is now picking up. The currency you use is another factor. It means that a deposit account in a currency such as the Rupiah can pay you a much higher rate of interest but the higher rate can be wiped out by the relative devaluation of the currency. An important factor to consider if you plan to retire in Bali for example.
To illustrate the impact of inflation you can use a mathematical tool known as the ‘Rule of 70’. It is not precise but close enough to provide a good rule of thumb estimate. The way it works is that if you take a given level of inflation, let’s say 5% per annum, divide it into 70 and it will tell you in how many years the purchasing value of your money will be halved, in this case 14 years. Should inflation reach 10% you are looking at just 7 years. Another 7 years at the same rate and your fixed income from say an annuity or frozen pension (as suffered by many UK retirees in Bali) will be getting close to worthless.
Once you have the figures, where do you go from there?
The fact is that many, if not most people, will find there is a shortfall. There may be a big gap between the dream and reality. If time to retirement is short, some will panic and risk falling into one of two traps. The first is driven by fear and results in staying ‘safe’ and keeping all assets in cash.
There is a new term for this: ‘reckless conservatism’. The second is to seek out investments promising high returns, only to discover they result in heavy losses. So what is the best strategy to follow? The answer is not a simple one; there is no ‘one size fits all’ so I will explore the options in my next article. Do write if you have any related questions I can address, anonymously of course, four weeks from now.
Colin Bloodworth, Chartered Member of the Chartered Institute for Securities and Investment (UK), has spent over 20 years in Indonesia. He is based in Jakarta but visits Bali regularly. If you have any questions on this article or related topics you can contact him at firstname.lastname@example.org or +62 21 2598 5087.
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Copyright © 2018 Colin Bloodworth