The choices we face as investors are not just between shares and funds, bonds and equities, income and growth. Arguably the most important decisions we make are around estimating the unknowable targets we set for our future financial goals.
Among these goals, the biggest target is our retirement date. Most people long for the day when they don't have to toil away and can instead enjoy uninterrupted leisure. In setting this date - whether it is in our 40s, 50s, 60s or 70s - we are acutely aware of running the risk that we work too hard and save too much, or that we work too little, save too little and run out of money in our old age.
But despite reams of software devoted to lifetime cash flow modelling, used avidly by financial planners, it is impossible to run a fool-proof model. There are too many 'what-if' scenarios, even taking into mutually agreed assumptions about inflation, investment growth, interest rates and longevity.
Investors Chronicle reader 'The Joyful Investor' recently summed up the dilemma in a recent post on our website:
"The comment that "you can save too much" ignores:
1. The risk of a major financial crisis sometime in the 20 or more years left to you and your wife that reduces the value and income from your savings.
2. The possibility that inflation comes roaring back to reduce the purchasing power of your portfolio and its income.
3. The possibility that you might want to help out a family member sometime in the future, using some of your capital.
4. The possibility that a long illness will force you and/ or your wife to go into a care home or have live-in carers, which can easily cost 50,000 pounds a year.
5. The possibility that you might want to leave as much as you can to your family."
Just to confuse our Joyful Investor further, a new report has this week blown even the basic assumption - that we all should aspire to invest towards a set retirement date - out of the window.
Since World War II, retirement has gone from a fringe to a mass phenomenon in western countries. But, overall, the theoretical relationship between retirement and health has been at best ambiguous.
Many have sought the dream of 'no more job stress, no more problems', while others have subscribed to the 'retire today, risk dropping dead tomorrow' line of thinking. In the second camp is my own father who is still working at age 72. Heavily influenced by his own father's experience of retiring without any occupations beyond reading the newspaper and smoking cigarettes ultimately leading to a life of boredom, followed by a relatively early death, my father launched a second career in his mid-50s.
This was based on a 'good hunch' that not retiring would be good for his mental and physical health. Any research aimed at proving the validity of this hunch has previously been difficult. For, just as retirement can influence health, health can influence retirement decisions - meaning many studies suffered from methodological problems, or difficulties in separating the short-term from the long-term impact of retirement.
But now, at last, we are presented with the unequivocal evidence that retirement is truly bad for you, reducing physical and mental health. The ground-breaking research from the Institute of Economic Affairs has found that "Higher state pension ages are not only possible (given longer life expectancy) and desirable (given the fiscal costs of state pensions), but later retirement should, in fact, lead to better average health in retirement."
Whether we are still some time from retirement or contemplating retiring tomorrow, we need to factor this new 'retirement is bad for you' evidence into our financial plans. Most of us are working to a cut-off date, a cliff edge of retirement - that now may look unwise.
The policy implication of the research is that policymakers should remove disincentives to continue work in old age. These include impediments to later retirement that are to be found in the state pension systems, disability benefit provision and employment protection legislation.
The most common age at which most people are aiming to jump off the cliff edge into retirement is 65. But those of us aged under 40 and expecting a state pension later than our desired retirement age have already accepted that our plans for retirement are disjointed. In the UK, governments have increased the state pension age, which will reach 68 for both men and women in the coming decades and further increases are likely to follow.
It is time to accept that financial plans need to be kept fluid and flexible. We can all be a bit more lenient on the amount we need to save now if we should be planning on earning more in later life.
Retirement should be a gradual phasing in of income to free up spare time - but not necessarily to stop working or earning. This means investment has to be flexible. There's no point putting your entire assets into bonds prior to a chosen retirement age if you then decide to work a few more years. Importantly, perhaps we can be bolder with our investment decisions, moving to higher-risk assets, if we know that our earning power should ideally continue into later years.
