1.3.1 Retirement: the longest time horizon
Planning for retirement is the most important aspect of investment management.
The scale of the funds that need to be accumulated for a comfortable retirement dwarfs those needed for other investment goals like saving to buy a house or car, or to pay school fees.
The time span between commencing retirement planning and cashing in the investments to provide income in retirement can – and should – span decades rather than years.
Growing longevity also means that despite the choice of many to work well into their 60s, the time period spent in retirement is, on average, growing, with the related implications for the resources needed to provide an adequate pension income.
To consider how an individual or household can plan ahead for their retirement years, a robust financial planning model needs to be adopted and applied. This, or similar planning models, would be used by a financial adviser as the foundation for advice about retirement planning and provides an approach that you can also use for yourself.
Central to the situation is the goal of a comfortable retirement. The need is to have enough income throughout retirement to finance a certain standard of living. The amount required will be determined largely by expectations of spending in retirement.
This raises a question: whose spending needs? Should the financial plan look at the individual or the household? The danger of basing the plan on the household is that many households change over time as, for example, couples split up, family members and friends decide to share a home or leave, or people die.
Traditionally, married couples have adopted the household approach, and the resulting financial plans have often proved inadequate in the face of death or divorce. This is a key reason why women account for such a high proportion of the poorest pensioners today.
The advantage of a retirement plan based on the individual is that each member of the household has their own pension arrangements, which they retain even if the make-up of their household changes.
Spending in retirement can be estimated from the individual’s or household’s current level and pattern of spending. Yet there are some good reasons to think that spending in retirement may be different from spending while working, and that spending needs in early retirement may differ from those later on.
An alternative might be to base estimated spending needs on the spending patterns of current pensioners, but bear in mind that what today’s pensioners actually spend may reflect the constraints of the income they ended up with rather than the income they wanted to have.
Note that Week 5 of this course is entirely devoted to the key personal investment matter of pension planning.