The question of asset allocation is key for retirees. Since the onset of the global financial crisis, markets, and equity markets in particular, have shown considerable volatility and while an investor with 20 or more years to retirement may be able to ride out such volatility, investors close to, or already in retirement do not have the same luxury of time.

For investors who need to provide themselves with a regular income in retirement, these dips in equity markets may cause them to eat into their capital base and there may be limited opportunities to rebuild this capital base.

For this reason, investors in retirement should be re-evaluating their asset allocation, with a focus on moving some of their portfolio away from riskier, volatile markets, and moving more of their allocation towards defensive, less volatile asset classes like fixed income.

Your objective

A key driver of levels of allocation and style of assets investors should hold is, “what are you trying to achieve from your investments in retirement?

As a retiree, are you really looking for growth? What is really important to you at retirement age?  Do you really want your portfolio to double over the next 20 years or do you want your portfolio to provide a steady income? If you answer yes to the latter, then ensuring income is locked in should be a key focus.

While fixed income investments, by their nature, provide a regular cash payment stream, investors are still often looking for their investments to provide a higher income. This has led to the re-emergence of a product once considered a little old fashioned, the annuity.

What is an annuity?

As annuities return regular cash flows, they are usually classed as fixed interest investments. This is because, on the surface, they are not unlike a fixed rate mortgage, where the annuity investor is the equivalent of the lending bank. The investor, in return for purchasing the annuity, receives a regular repayment that comprises an interest and principal repayment, until the principal balance is zero.

By repaying both interest and principal, an investor is able to receive an increased income from their investment, with the trade off being the repayment of the principal portion over time.

Indexed annuity bonds versus retail annuities

Only life insurance companies can issue retail annuity products, but some bond issuers issue Indexed Annuity Bonds (IABs). These are effectively an amortising loan with the interest indexed to CPI and, as such, share similar traits to a retail annuity.

IABs will often provide returns superior to retail annuity offerings as all of your investment return is returned to you, the IAB provider does not retain significant amounts of your return to pay for advertising, administration, commissions, APRA capital standards etc.

By directly owning an IAB, you also have the added flexibility of being able to exit your investment if something does happen and you need to access your money.

What retail annuities do offer over IABs is the tailoring of exit dates. As a bond, an IAB has a set maturity date, which may or may not suit an individual investor. They also do not offer a ‘whole of life’ option.

Who issues IABs?

As most companies in Australia choose to issue ‘bullet’ loans (like an interest only loan) rather than amortising loans, IABs tend to be issued by projects with definitive time lines, and in particular are issued by a number of social infrastructure PPPs.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.