Record share prices and what they mean for your retirement

The Australian share market has finally reached new highs, more than 11 years after the Global Financial Crisis (GFC) decimated share prices and retirees’ nest eggs.

That’s right.  It took the Australian share market more than 11 years to recover from its previous high. 

It’s important to reflect on that when we hear investment professionals tell us that share markets can be “volatile in the short term”, that investors should “ride out volatility” and that “it’s time in the market, not timing”.

Eleven years is a long time to hold your breath under water

But 11 years is no short-term blip.  What’s clear is that when you’re investing for your retirement, timing matters. 

Timing matters because most people need to spend down their money in order to live during their retirement.  They simply can’t afford to sit and wait for the market to recover. 

Memories are short

After so many years of strong positive share market returns, people forget those who retired at the height of the last market cycle.  Those retirees really suffered when the share market collapsed during the GFC, and most will never recover financially.

They won’t recover financially because they spent their money in order to meet their living requirements when share prices were depressed.  They effectively sold down their assets and locked in their losses.  So, the money hasn’t been available to participate in the market recovery.

The mistakes we all made

Most investment professionals in the world make their portfolio decisions by applying what economists call ‘Modern Portfolio Theory’.  That theory was introduced in a short article in 1952 by the Nobel prize winning American economist, Harry Markowitz.

The investment industry latched on to Modern Portfolio Theory immediately.  It introduced concepts like diversification, or ‘not putting all your eggs in the one basket”, in recognition that different investments respond differently at different time of the economic cycle.  It saw the introduction of ‘Balanced’ managed investments, split between growth and defensive assets.

The trouble is, like so many ground-breaking ideas, it was misunderstood, and the financial planning industry over-reached in its application.

Markowitz recognized this, and he sought to correct the situation in 1991, when he wrote an article clarifying that Modern Portfolio Theory applies to institutional investors, but not to individual investors. 

That’s because the investment challenge is different at a personal level, where you have two important constraints: you’re time-bound and you need to withdraw money to live on.

What we can learn from the past

That explains why so many retirees blindly carried forward their balanced portfolios from their working lives into retirement.  And during the GFC they paid an unfortunate price.

What’s clear is that investing for retirement requires a different approach.

If you’re within five years of retirement, then record share prices today mean that you need to start investing differently right now.  You should start planning for your future withdrawals and set the money aside so that you know it will be there when you need it.  It’s what investment professionals call asset liability matching.

If you’re already retired, then record share prices may mean that you’re ahead of where you expected to be.  It’s time to reach out to your adviser and investigate how to sensibly de-risk your portfolio.  Nobody ever went broke taking a profit.

With When Financial Solutions, we can help you build a strategy for your retirement that can withstand the market cycles.  Because just as night follows day, investment busts always follow investment booms.  It’s really not a matter of ‘if’, but ‘when’.

Michael Bowman and James McMaster are co-founders of When Financial Solutions