Have you thought about doing this with your ILLA?

The reason we save and invest is so that we may have enough money at a point in time for a particular goal. Much time and effort is spent on analyzing how and when to invest. But not much energy is spent on thinking about the method of withdrawal from your investment.

Over time, most people’s life expectancy has increased. People also aim to retire earlier. So with longer lives and earlier retirement, investing during retirement becomes a tricky proposition.

There is no simple solution because every individual’s needs and constraints differ, but the choices available (e.g. an ILLA or traditional life annuity) need not be mutually exclusive. A well thought out combination of products may achieve your goals more efficiently. Currently an ILLA (Investment Linked Life Annuity) is a very popular product for income provision during retirement.

The dangers of an ILLA are that you will destroy value by withdrawing income during times when the market is down, or that your money runs out while you are still healthy. You have to worry not only about short-term volatility, but also long-term underperformance. So, if you are invested in an ILLA what is the best way to manage your money?

To combat the risk of long-term underperformance it is necessary to invest more aggressively. Over 90% of returns are determined by asset class selection and in this case it means more equities and offshore assets.

We tested two different asset allocations, one with 30% equities and the other with 60% equities across a wide range of economic scenarios and in 90% of these the high equity portfolio provided better growth in capital and income.

The downside of this strategy is that it increases the short-term volatility and hence the risk of destroying capital. To combat this, an investor could withdraw income from a cash account. An investor has the option to sell assets proportionately to draw an income or to draw an income solely from cash. Simulations suggest that in 88% of the cases, withdrawing from cash gives you a higher growth rate in both capital and income.

It is important to note here that withdrawing from cash doesn’t mean changing the asset allocation to provide for a cash portion. Most ILLA portfolios have between 10%-30% in cash as it is. Further adding to this cash to provide for an income will not have the desired effect.

While it is very understandable that individuals panic in difficult economic circumstances, it is imperative that their emotions do not negatively influence their actions and hence their investments. It is vital that investors remember that the term of an ILLA could be up to 30 years or more. An ILLA is a long-term investment in the truest sense of the word – a short-term focus could be disastrous to the continued provision of an adequate real income.