In Challenger and Ensombl’s new report, Practical strategies to mitigate the impact of inflation risk on retirement incomes, they said financial advisers are using a combination of client-driven lifestyle changes, asset allocation, and product strategies to tackle inflation for clients who are retired or approaching retirement.
Challenger’s head of retirement income research, Aaron Minney, said for Australians either in or approaching retirement, the outlook for 2023 remains challenging.
“Inflation, which had long been forgotten, is today an insidious risk for retirees. With an annual inflation rate running at more than 7 per cent, it erodes retirees’ spending power, tempting some to draw down additional savings,” Mr Minney said.
“While volatile investment markets also present risks, inflation tends to amplify them considerably and is usually more enduring. Inflation can have a particularly large impact early in retirement, when increasing drawdowns to cover rising costs can amplify other issues like sequencing and longevity risks.”
The report said the impact of inflation on a retiree’s lifestyle can be dramatic, with the effect of inflation causing additional risks without a wage or salary also increasing with inflation, as the purchasing power of their investments can erode.
Ensombl chief executive Clayton Daniel said there are many different ways to mitigate the impact of inflation on retirement income, which generally fall into one of three high-level categories: client-initiated lifestyle changes; asset allocation and portfolio construction strategies; and product selection strategies.
“To the extent that every retiree’s circumstances are different, the specific responses and strategies being employed at an individual client level are both many and varied,” Mr Daniel said.
“However, after speaking to financial advisers around Australia, it is clear that managing inflation risks will require clients to consider reducing or deferring living costs, while revisiting their retirement strategy — the products and assets they invest in.”
In terms of lifestyle changes, the report outlined three levels: major, modest, and minor. A major change could include moving to a smaller residence and/or a new location, while a modest change could be delaying the purchase of a new car or an overseas holiday or installing solar panels.
Minor changes include smaller alterations to a household budget, such as making dietary changes, shopping around for cheaper groceries, wine, and petrol, ceasing streaming subscriptions, or going to the cinema less.
The report also highlighted that commodities and infrastructure are among the asset types that generally respond positively, and quickly, to inflation, adding that stocks linked to these assets have performed relatively well recently. Alternatives, real estate, and inflation-linked bonds are also better positioned for a high-inflation environment.
Challenger and Ensombl also said that the optimal retirement income strategy will often comprise a tailored mix of age pension, account-based pensions, and a lifetime annuity.
“Adjusting this mix can therefore be just as important as rebalancing allocations within the market-exposed elements of their portfolios,” the report said.
“Adjusting this mix takes on increased importance in times of higher inflation, as some product solutions, and some options within product categories, are more effective inflation mitigants than others.”
Mr Daniel concluded: “It is essential advisers are equipped to help their clients navigate a path that optimises both their income and the longevity of their investments.”
