Retired investors typically look for security in their investments ahead of return. Superannuation payments barely cover the cost of living from day to day and saving in retirement is not possible without a frugal lifestyle. This means that any loss of capital from failed investments cannot be recouped from income.
Some retired investors fail to realise however, that loss of capital doesn’t only arise from failed investments. An investor with $100,000 in bank deposits, who uses the interest to supplement income, stands to lose over 20% of his or her capital over the next ten years just by leaving it in the bank. Let me explain why.
A ‘basket of goods’ that cost $100 in December, 2000 would today cost around $131. If we project that same average rate of inflation forward, $100,000 in the bank today will only buy the equivalent of around $77,000 worth of goods in ten years time. That is a loss of around $23,000 over the ten years. Not only that, the income from the investment will fall in value. If, for example, interest rates are 6% on average over the next ten years, the income from $100,000 would be $5,370 per annum after tax at a10.5% rate. In ten years time, however, that income will only buy around $4,130 worth of goods in today’s terms. A retired investor who invests for income and uses all that income every year will therefore suffer a significant loss of both capital and income over the long term. Given that many people spend twenty or even thirty years in retirement, the potential loss of capital and income is huge.
How can this be avoided? Investing a small part of your retirement nest egg in a diversified portfolio of growth assets will help prevent losses from inflation and tax.