Spending financial assets
Richard and Lynne have just retired. Richard is 67 and Lynne is 65. They own their home (value about $300,000) and have savings of $150,000, mostly money that Lynne inherited when her mother died. NZ Super gives them a net $22,164 a year, enough to pay for basic living expenses.
Based on average statistics, Richard is expected to live an average 16 years and Lynne 21 years. They want to see how much of their capital they can spend each year, so they ask for advice.
They’re told that if they want to “do it yourself”, there’s a simple way for them to organise their spending. On average, the money has to last for 21 years (until Lynne’s expected death). This means they can spend $150,000/21 years or $7,100 a year of their financial capital. The investment earnings will be a “bonus” each year.
To make sure the money will be there when they need it, the next three years’ spending (3 x $7,100 or $21,300) should be put on term deposit at their bank.
Spending over the period between three and, say, 10 years away (7 x $7,100 or $49,700) should be invested in bonds with about $7,000 maturing in each of those years. They should buy the bonds themselves directly – not through a managed fund. It’s cheaper that way, and they won’t then need to worry about changing interest rates affecting the value of the bonds.
Richard and Lynne won’t be spending the rest of this money ($78,100) for more than 10 years. That long-term spending money should be invested in shares. That’s partly because expected returns from shares over that kind of period should be better but also to protect their spending against unexpected inflation. For this amount, they’ll need to use a managed fund of some kind for shares.
At the start of their retirement, that gives them a portfolio mix of:
- Years 0-2 (inclusive) - cash: 14%
- Years 3-10 - bonds: 33%
- Years 11+ - shares: 53%.
As time goes on, their savings will migrate from shares to bonds to cash so the proportion held in shares will reduce each year. However, they can vary their spending if it looks like the expected period is either shorter of longer than the average of 21 years. If everything works out then Richard and Lynne’s final three years of spending will all be in cash. And they will be close to achieving their objective of spending all their financial savings without having to “eat their home”. The survivor can pass that on to the children.
