By Rocco Carr, 28 September 2021
The dictionary meaning of diversification comes down to the process of starting to include more different types or things into an existing package. Investopedia explains it as a risk management strategy that mixes a wide variety of investments within a portfolio to limit exposure to risk.
Many people think that diversification in retirement is limited to the choices between guaranteed annuities and living annuities.
During periods where markets struggle, guarantees are often favoured for the sake of security. Due to the uncertainty in markets, guaranteed rates are then often higher as bond yields will be elevated to compensate for the risk. This was evident after the COVID crash.
In contrast, during periods of strong market rallies, investors often assume that the good news will continue, and that the double-figure market returns will always be available. During such a stage, investors tend to focus more on living annuities. This choice between the two options, however, can be labelled as the first layer of diversification.
This is a starting point, but this does not incorporate true diversification. Ideally one needs to be prepared to take a step to diversify even more.
Combining solutions can be described as the second level of diversification, where the features of each product are blended into a solution. The guaranteed annuity protects you against the risk of longevity, while the living annuity offers flexibility in income as well as the prospect of a legacy.
At this point, one ventures beyond the normal notions of diversification by bringing the concept of time into the equation. The future might hold unforeseen stumbling blocks and/or opportunities which might not currently be real or expected. The management of your future income stream is paramount.
Should you at some point run into a dire situation where extra income is urgently needed, such as a medical condition not fully covered by your medical aid, the flexibility of the living annuity income withdrawal might emerge as a solution. Since the income may be altered once a year, you will then have the option to increase the income from the living annuity for a year or two to cover the extra expenses.
Although this might not be an ideal solution, the flexibility can solve a serious problem. The living annuity therefore can double as an emergency fund for the future.
Another opportunity that might arise is the purchase of a second life annuity somewhere in the future. Guaranteed rates in the future, when you are older, might present another bite at the guaranteed apple, but at a far better rate than might currently be the reality. Instead of locking all guaranteed rates into a single event at retirement, the combination allows for the diversification of entry points into a guaranteed environment.
Some platforms offer the opportunity to split the remaining living annuity into another combination, which means the flexibility of a portion in a living annuity does not need to be fully discarded at that point. However, platforms that do offer this functionality are very limited, so due consideration of the platform used is necessary to allow the third layer diversification.
Retirement diversification is far more than just selecting the most appropriate option at the time of retirement. True diversification at retirement should be more about how different retirement products can be blended to cover immediate and possible future needs. True retirement diversification is therefore not only about fund choice or asset and geographical blend, but also about product combinations and diverse entry points along a future timeline. Such a multi-layered diversification model is the only way to effectively manage future income streams.
This is why we strongly recommended that you consult an appropriately accredited financial adviser regarding your unique circumstances and needs as you enter retirement.