Capture spread key to retirement outcomes

Understanding capture spread will allow advisers and investors to deliver better outcomes in retirement, according to Fidelity.

Fidelity International head of client solutions and retirement, Richard Dinham, said while taking some risk in retirement was needed to avoid unpalatable outcomes, limiting downward movements in retirement portfolios was even more important than capturing the full upside in markets.

“You can’t spirit away market risk but you can sensibly manage it,” he said.

“Retirees still need to take appropriate investment risk to address inflation and longevity risk, but there also needs to be a focus on the impact of market volatility on retirement outcomes, known as sequencing risk.

“While the positive impacts of compounding and dollar cost averaging are well understood when it comes to saving, many people are not aware that the opposite is true during decumulation. In fact, limiting losses in retirement has a more powerful effect on long term growth than capturing the full upside of market gains.”

Dinham said the compounding effect of investment losses – downside capture – could have a devastating effect on retirement portfolios.

“Accordingly, the right kind of equity risk in retirement should come with excellent downside capture to protect in down markets and a capture spread that enables sufficient participation in the market upswings. This approach has been shown to deliver better outcomes in retirement,” he said.

He said less downside capture hugely improved compounded returns, gave portfolios a smoother ride, and protections from the worst of equities markets.

Dinham pointed to examples of what positive returns were required to break-even after market losses. He said a portfolio that lost 10% would need to capture 11% of the upside to break-even. However, a fund that lost 40% would need to return 67% to break-even, and a fund that lost 50% would need to return 100% to break-even.

“When people are saving for retirement, the focus tends to be solely on performance.  While that may be appropriate during the accumulation phase, it fails to address the complex needs of those people approaching retirement or in retirement,” Dinham said.