Tackling the “Nastiest, Hardest Problem in Finance”

Apr 29, 2019, 18:03 PM

29 April 2019, by Colin Horwitz

By the time you read this Easter will have come and gone. I trust that everyone enjoyed their Easter break and had a restful long weekend.

The heading of this article was coined by William Forsyth Sharpe. William Sharpe is the Professor of Finance Emeritus at Stanford University’s School of Business. He was the winner of the 1990 Nobel Memorial Prize in Economic Sciences and was one of the originators of the Capital Asset Pricing Model.

What he was getting at when he said this was the following; Retirement is a two-edged sword. We deal with many variables that affect our retirement. Some of them are market volatility, global as well as local economic volatility, inflation, interest rates and last, but not least, there is an element of luck. Think of it this way!

For most individuals reaching retirement age, retirement is a planned event. We should know in advance the retirement age stipulated by our contracts of employment and the rules of our retirement funds. Some of these rules allow for an extension of employment but in most cases, an individual’s retirement date is set. The day after that retirement date most people wake up to find that normality has disappeared. What you were used to and had become your status quo for the past 45 or so years as routine, is no more. Life, as you know it has changed and the biggest change is your ability to earn an income. The luck part of it comes in to play as to the timing of the event. Let’s face it, we have all seen a dramatic deterioration in the returns that our investments have generated over the last few years and if you had retired in December 2018, you would have, likely, found that your retirement savings at best equalled the value of the same time a year earlier. Some may have been luckier as some retirement funds change the portfolio of those close to retirement to cash or cash equivalents, but even cash returns were not great. So, as far as I am concerned, luck is a player.

Getting back to Prof. Sharpe and his quote. What he was getting at is that there are two elements to your retirement income. The first is to be able to provide an income from your capital that will allow you to live at a reasonable standard, preferably the one that you enjoyed before retirement. The second is to enable a return from your capital that will allow growth, that enables inflation linked increases to your future income. Here is an example:

Lets say that you initially require a 5% per annum drawdown, paid out in equal monthly instalments, on your retirement capital to fund your lifestyle. Let’s assume that inflation is 5%.  This means that you will require a return of roughly 9,8% on the remaining (after the monthly payments) capital to provide you with an annual increase equalling the inflation of 5% in a year’s time and in the next year and so on. This is the crux of obtaining a balanced retirement investment.
I trust that this short explanation assists with future decisions and I remind you that we are here to assist you to make the right decisions based on your requirements. We will also tell you if your aspirations have been set to high and will be able to advise and assist you with your budgetary requirements.

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Here’s hoping that all goes well with the elections and that our beloved country can get rid of all it’s skeletons, move forward and get healed.

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