Financial advisers often recommend investors of working age keep six months’ worth of their salaries in cash to avoid having to liquidate investments in case of redundancy or emergencies. For retired investors, the same principle of keeping cash aside to meet short-term needs applies but is amplified.
A buffer of liquid assets, such as cash deposits and money market funds, helps avoid having to sell equities after a market fall and crystallising losses. This is especially important for investors in the decumulation stage who need to mitigate against sequencing risk (making big losses early on when their pension pot is largest).
But how much money should retirees hold in cash and equivalent assets?
Henry Cobbe, head of research at Elston Consulting, recommends that retired investors square off three years’ worth of their income needs into money market funds, which “can be used as a liquid source of yield with near-nil volatility”. Setting aside such an ample buffer enables retired investors to put the rest of their wealth to work in higher risk investments to keep growing their pot.
Helen Morrissey, head of retirement analysis at Hargreaves Lansdown, believes retired people should have between one and three years’ worth of essential expenses in an easy-access cash account. These savings can be used to “supplement periods of time when volatile investment returns impact how much money you want to take from income drawdown”, she explained.
Other experts recommended hiving off a smaller amount of cash for emergencies, complemented by low-risk investments that could be liquidated if necessary.
Edward Allen, private client investment director at Tyndall Investment Management, said: “I would try to think about likely liabilities, which could range from unexpected health costs to the car breaking down. A sensible range of investments should contain some low-risk assets that could be divested if needed. Assuming those low-risk investments exist, for many retirees the cash buffer need not be huge – sufficient to cover a few months’ expenditure.”
Brown Shipley advises retirees to keep around three months of expenditure in cash as a buffer against unforeseen events, although the exact amount is completely subjective, said Jeremy Croysdill, executive director, wealth planning. “We find some clients wish to keep large amounts in cash, while others will have nearly all their money invested,” he noted.
“Older retirees may have more flexibility with the amount of their emergency fund due to having regular and often guaranteed income from pensions and investments, meaning they don’t feel they need a large pool of liquid capital. But again, it’s hugely dependant on what they find important in the lifestyles that they wish to lead.”
How should the rest of the pot be invested?
Elston, which specialises in research around retirement investing, proposes three buckets for different time segments.
The aforementioned money market funds are used to meet near-term liquidity requirements. Then absolute return or diversified alternatives funds serve as “a stabiliser for the next five years to give above-cash returns but with limited downside risk”, Cobbe explained. Finally, multi-asset income and/or equity income funds provide long-term growth, depending on risk tolerance.
The absolute return, multi-asset and equity income funds would ideally pay out a monthly income stream to help retirees manage their cash flows, Cobbe added. Investors should periodically rebalance their buckets to keep the overall asset allocation on track.
Conversely, Richard Parkin, head of retirement at BNY Mellon Investment Management, thinks bonds will form the core of retired investors’ portfolios, along with equity income and multi-asset income funds. The bond allocation will likely be substantial so needs to work hard by delivering predictable income with some capital growth, whilst also helping to diversify the portfolio and manage risk, he said.
Cobbe, however, does not see bonds as a major investment for retirees because inflation can eat into returns. “For someone aged 65 with average life expectancy, a bond fund isn’t enough to ensure portfolio durability. Whilst higher yields now make for a more interesting entry point, most retirees will need a multi-asset portfolio to last the course. Bonds alone are not enough,” he argued.
Multi-asset and equity funds
For the longer-term tranche, Elston has designed an index of exchange-traded funds (ETFs) with exposure to equities, bonds, listed property and infrastructure securities. The Elston Multi-Asset Income Index uses SPDR Dividend Aristocrats ETFs for equities, which select stocks based on a track record of dividend stability and growth.
Investors can gain access through the VT Elston Multi-Asset Income fund, which aggregates dividends from the component ETFs and makes monthly pay-outs.
For investors wanting to pick funds themselves, a higher risk/return option is Vanguard Global Equity Income, which Cobbe described as a “yield-oriented global equity tracker fund”.
He tipped Invesco Global Equity Income for investors who prefer actively-managed funds. It is managed by Joe Dowling and Stephen Anness and has delivered top-quartile performance over one, three and five years.
Parkin believes equity income funds are ideal for retired investors because they tend to keep pace with inflation and grow their income stream. They usually fall less than the wider market during downturns and are not as volatile as growth-oriented strategies.
He recommended BNY Mellon UK Income, managed by his colleagues David Cumming and Tim Lucas, which is also a top-quartile performer over one, three and five years in the IA UK Equity Income sector.
Active managers often struggle to keep pace with raging bull markets but they are better at cushioning their portfolios against downside risk, Parkin continued, and for retired investors, limiting losses is usually more important than maximising gains.
For more ideas, Trustnet recently asked experts to recommend equity income, multi-asset and bond funds for retired investors.