Most of us are well aware of the importance of saving and investing to build our wealth for retirement, and some already have a sound financial plan.
But we rarely plan how to draw down those funds when we retire.
What is decumulation, and why is it important?
Decumulation is when we convert the assets that we have accumulated during our working years into an income stream for retirement.
When it comes to decumulation, the majority of people may be concerned about potentially outliving our retirement funds.
The global population is generally living longer, thanks to advances in medicine and technology.
Hong Kong’s life expectancy is among the highest in the world, at 83.2 years for men and 87.79 years for women in 2021. That suggests the average Hong Konger will need to have enough retirement funds to last some 18 to 23 years after the retirement age of 65.
Having a decumulation plan in place can provide us with financial security and peace of mind so that we can live better and enjoy our golden years.
Decumulation is difficult if we don’t start earlier
46% of Hong Kong women and 43% of Hong Kong men are not confident of having sufficient funds for retirement, according to Fidelity’s Global Women & Money Study 2022. The study also found that women in Hong Kong expect to retire at 63 and then to rely on HK$22,000 per month on average for 21 years, while men expect to retire two years later, and to fund 20 years in retirement on HK$23,000 per month on average.
There are several behavioural biases among retirees that could result in poor financial outcomes. A PIMCO research study found overconfidence, loss aversion bias, and health-related anxieties among investors, which would hinder the decumulation stage of retirement.
For example, over half of the respondents either had no plan or planned to ignore their assets completely in their retirement. Despite this lack of planning, 83% of them were highly confident about their ability to meet their retirement spending needs.
Investors may feel such confidence because they have already successfully grown their investment portfolios as accumulators. But, as PIMCO pointed out, successful accumulation does not guarantee a successful decumulation.
Its research team also found that loss-averse investors perceive market movements with strong emotions, which can lead them to impulsive and suboptimal decisions such as shifting to lower-risk allocations during steep market declines.
Moreover, anxieties around one’s health prompted some retirees to save more as a precaution while slowing their withdrawal rates of assets in mid-late retirement.
How to decumulate wisely in retirement
Therefore, even before we retire, it is critical that we start planning for our retirement goals and spending needs, as well as how we can maximise the income potential of our savings and Mandatory Provident Fund (MPF) or assets in the Occupational Retirement Scheme (ORSO).
To begin, identify your retirement needs and categorise them into essential and non-essential expenses.
Aggregate all sources of potential income — both guaranteed, such as payouts from annuity plans, reverse mortgages or government allowances, and non-guaranteed ones like dividends from equity investments.
Next, decide on your risk tolerance and manage the trade-offs between income and capital growth among the assets in your investment portfolio.
Track the cash inflows and outflows, as well as the portfolio performance. Maintain a flexible plan to address unforeseen life events and expenses.
The longer you wait to put together and execute a decumulation strategy, the shorter the runway you have to balance between maintaining an adequate standard of living and preserving enough assets to sustain your entire retirement period.
It is also important to note that your portfolio will need regular reviews and realignments with your current and expected circumstances.
How will higher inflation affect decumulation strategies?
The sharply rising inflationary pressures in 2022 have been chipping away at real investment returns and thus slowing the accumulation of assets.
This makes it tougher for investors to maximise the value of their retirement savings to attain their preferred standard of living, and may disrupt their existing decumulation plan if they do not accumulate their expected amount of assets by the time they retire.
As a result, some individuals could decide to delay retirement, lower their standards of living, or find alternate sources of income, such as taking up part-time jobs if their physical health allows for it.
The key to tackling these challenges lies in planning for retirement early. Set a clear savings plan during your working years, invest early to let your money work for you through the power of compounding, and actively monitor and reassess your decumulation strategy to stay ahead of the economic and market conditions.
Explore your income-building options with Endowus, get started here.
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