Can you imagine living to 100 years of age? Some people can.
Remember, at the turn of the last century (that is, 1900), the average life expectancy for an Australian male born in that year was 51.1 years. Women fared a little better, with a life expectancy of 54.8 years.
For a person born in 1953 (that is, someone who is now 63 years of age), the life expectancy had risen to 67.1 years for men and 72.8 years for women. For a person born in 1986 (that is, 30 years ago) the life expectancy had risen to 72.9 years for men and 79.2 years for women.
Remember, these are average life expectancies. The average figures are ‘pulled down’ by people who die early. This means that people who have not died early can expect to live longer than these average life expectancies. For example, the life expectancy for a person already aged 65 (that is, born in 1951) is 84.2 for men and 87.1 for women.
No great surprise: if you do not die, you live longer.
Good news, hey? If you have made it to 65, you can expect to live at least a further 20 years. And, again, that is an average. Many people will live much longer; many people will live to 100.
So, here is a question: will your money last as long as you do?
Many people tend to become very conservative with their money when they approach retirement. This is fine in theory, but can become problematic in reality. It all boils down to how you define conservative.
Conservative typically means to preserve wealth. Many people think that means moving away from ‘growth asset classes’ such as shares or property and towards ‘lower-risk’ options such as cash and its equivalents.
But this tendency can create its own problems. Especially if you define conservative more pragmatically: preserving spending power.
As of 30 June 2016, the yield on 10 year Australian Government bonds is at an all-time low, at 2%. For the 12 months to March 2016, Australia’s inflation rate, as measured by the CPI, was 1.3%. This means that, on average, prices are rising by 1.3% per year.
In theory, as long as the bond yield is higher than inflation, the investor in bonds is not losing wealth. But, again, the average figures can be misleading. Within the CPI figures there were some specific changes. Communication costs fell by 6.4%. But health prices rose by 4.6%. This is 2.6% more than the yield on the bond. (Alcohol and tobacco rose by 6.1%, or 4.1% more than the bond yield).
Let’s say that you have newly turned 65 and you have $300,000 available to you. The ‘conservative’ option, now that you are retired, might be to invest that money in a bond that is paying 2% per year. However, now consider what that option will allow you to buy in 20 years’ time, when you are approaching the end of your life expectancy, and are most likely to need to find a bed in an aged care facility.
Aged care is a health cost. And health costs are rising by 4.6% per year. This means that a bed in an aged care facility that currently costs $300,000 can be expected to cost $737,000 in 20 years’ time. The bond will deliver you 2% per year. If we allow that to compound over 20 years, your $300,000 will only be worth $445,000.
$445,000 is 60% of $737,000. Taking the conservative option of the long-term bond will mean that, when you turn 85, you will only be able to buy 60% of a bed in an aged care facility that you could buy entirely if you were 85 now.
I guess that is good news if you can find someone nice to buy the other 40%, and you share the bed.
The problem with the conservative option is that it does not preserve purchasing power as well as growth investment options. And it is purchasing power that is critical. The conservative option of the bond is actually a high risk one, when you consider what you stand to lose over the long (but life-expected) term.
The point of all this is that you need to be very careful about becoming too ‘conservative’ with your money. More accurately, you need to be clear about what conservative really means.
Conservative means preserving purchasing power. To do that, you need your wealth to grow by at least as much as the increase in relevant costs, such as health.