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It can be a worrying time for Australian retirees when the share market falls. Many of them intend to rely on ASX shares and other profitable investments to fund theirs retirement.
Therefore, if S&P/ASX All Ordinary Companies Index (ASX: XAO) is set to fall by more than 12% — as in 2022, pensioners may be nervous.
Introducing Minchin Moore Private Wealth Partner and Director Ben Smith to offer some advice.
What can retirees do with market volatility?
Smythe writes in Australian Financial Review (AFR) about “the reality of sequencing risk [becoming] more care’ for Australians close to retirement.
Sequence risk refers to the sequence or order of income – particularly negative income – occurring at the same time as you start receiving capital from your SMSF (self-managed retirement fund) to fund your retirement.
A bear market in terms of investment returns in early retirement can put a significant strain on the capital that supports your retirement. The amount of stress will be determined by your living expense blueprints and capital set aside…
If you are forced to sell depreciated assets to cover living expenses, the ability to recoup the realized capital loss will be incredibly difficult.
Here’s the good news…interest rates are rising
Smythe explains the importance of a cash buffer:
… the last one market volatility driven in part by aggressive interest rate hikes by central banks, which is beginning to translate into higher yields on cash and time deposits.
Building a cash buffer as you approach retirement is an incredibly powerful tool for reducing the impact of sequence risk, as it allows you to draw on living expenses from your retirement cash bucket rather than just other asset classes, which can be significantly more changeable.
The role of cash in your portfolio should be simply security liquidity and zero volatility. An added bonus now is that you can make a pretty reasonable profit as well.
As for how much cash you should have, a general rule of thumb is that retirees should aim to live for at least two years.
This balance will ebb and flow with withdrawals and investment income generated, but if you can hit this target it will act as a buffer if there is a prolonged bear market that affects other asset classes in your SMSF.
Can you buy ASX shares with your cash buffer?
Smythe says another advantage of cash is its ability to be exchanged liquidity for greater returns.
… a high cash buffer allows you to better segment your investments into communication and credit holdings if you don’t necessarily rely on either of these investments for liquidity.
Credit investments, in particular, will yield higher returns if you are happy to give up liquidity, which can significantly increase the expected return on your defensive component.
If you are able to generate higher returns from your defensive assets to offset the decline in your growth assets, this will once again help reduce the risk of a sequence damaging your portfolio.
“Stock Markets Will Have More Good Years Than Bad Years”
In most cases, this long-term capital market return should be satisfactory if the investment strategy is well thought out and you have a suitable plan for financing cash flow needs in “bad” years.