For many SMSF investors, the drive to control investment for their retirement years is fuelled by the ultimate desire to control their attainment of ‘financial security’ in retirement, rather than leave it in someone else’s hands.
But how do you define financial security? And how do you map out a plan accordingly for a comfortable retirement?
At a detailed level, what constitutes financial security is defined differently for everybody, depending on their individual circumstances, goals and life experiences.
However, for most, the concept of financial security generally shares some common elements. These include ensuring essential living expenses are covered, having a contingency reserve for surprise life events, having access to a level of discretionary income to maintain a preferred lifestyle and, ideally, having enough left over to pass a legacy on to loved ones or for endowment purposes.
Vanguard believes that considering these four high-level categories is a great starting point for setting retirement planning goals, no matter what the underlying mix might be at the individual level.
When it comes to planning, these priorities can be further split into two broad categories – cash-flow goals and asset reserve goals.
Cash-flow goals include living expenses and discretionary income, and can be catered for in a number of ways, including government benefits, annuities or retirement income stream products, in addition to investment portfolio returns.
Asset reserve goals, to plan for contingency and legacies, require pools of assets that are big and liquid enough to meet what could ultimately be large and infrequent expenses, for example, extraordinary health or custodial care, or unexpected large-scale home repairs.
To further define financial security, and plan accordingly, there are also a number of risk factors that need to be taken into consideration.
Market, health, longevity, tax, event and policy risks can all have a distinct impact on your retirement goals to varying degrees.
How sensitive you are to these risks and understanding how exposed your portfolio is should assist with creating an appropriate asset mix.
Market risks encompass the risk of poor investment returns, the risk of inflation eroding returns and the impact of interest rate changes and market volatility.
In most cases a certain amount of market risk is necessary in order to meet return objectives and long-term goals, and it is, as such, quite an individual decision as to what level of risk tolerance is built into the asset allocation mix.
How an individual behaves during significant market events can impact hugely on the outcomes they experience later and this is one element where a good financial adviser can be invaluable.
To evaluate and plan for health and longevity risks – that is, the risk of not being able to afford the level of care needed due to deteriorating health and the risk of outliving your financial resources – a number of factors need to be considered.
Examining your personal risk in these areas in detail and considering how to resource it, be it through insurance or more contingency, can ensure you are better prepared for the unexpected.
Another key consideration when risk assessing is the risk of changing tax and government policy, including monetary policy. There are complex tax rules to consider with various impacts, particularly in the SMSF space, such as the much discussed $1.6 million cap on retirement savings, and the risk of further ongoing changes, which should all be factored into the equation.
Once goals and risks have been mapped out, those planning for retirement need to consider what resources are available to meet their needs, including guaranteed income streams, assets, insurance, home ownership, employment and other financial products.
Bringing it all together, the resulting plan should balance your competing goals, with the risks you have determined you may be susceptible and sensitive to, with the right mix of resources and investments.
Having a plan tailored to your individual circumstances and having the conviction to stick with it over time, rebalancing and adjusting as needs and circumstances change, should certainly set you on the right road to a successful retirement.
And while there is no catch-all formula for building the perfect plan, nor is defining financial security a straightforward matter, an informed and well-considered strategy and good understanding of what end goals are should ensure you sleep better at night.