Last Updated on 25/03/2025 by Carl-Peter Lehmann
Investment Returns for Retirement: When planning for retirement, many investors focus on saving enough money but often overlook one of the most crucial factors in achieving financial security: investment returns. Understanding the rate of return you need to achieve your retirement goals can be the difference between financial comfort and running out of funds too soon. In this article, we explore how investment returns impact retirement outcomes, illustrate the effect of even a 2% difference in annual returns over time, and discuss the risks associated with targeting higher returns.
Why Investment Returns Matter for Retirement Planning
Your investment return determines how quickly your wealth grows and how long it lasts in retirement. If your returns are too low, your savings may not keep up with inflation or your withdrawal needs. On the other hand, if you take on excessive risk in pursuit of high returns, you might experience significant losses that could derail your retirement plans. One of the most effective ways to understand the impact of returns is through a cash flow model. Consider two retirees with identical savings at the start of retirement:
• Retiree A earns an investment return of inflation plus 2–3% per annum, ensuring that their savings grow at a modest pace above inflation.
• Retiree B earns an investment return of 3–5% per annum above inflation, achieving a higher rate of compounding over time.
Over a 25–30 year retirement period, the difference in investment returns can be substantial. Retiree B (Scenario 1 in Dark Blue), with higher returns, may have a significantly larger asset base later in retirement, allowing them more financial flexibility and security. Meanwhile, Retiree A (Current in Light Blue) may find that their assets deplete more quickly, increasing the risk of running out of money in later years.
Further Reading: Some of the best performing balanced funds retirees can consider for their portfolios
The Risk-Return Tradeoff
Many investors understand that seeking higher returns typically involves taking on more risk. However, risk in investing is multi-faceted and extends beyond just market volatility. Here are three key risks that investors need to consider when constructing their portfolios:
1. Liquidity Risk
Liquidity risk refers to the difficulty of converting an asset into cash without incurring a significant loss. Some investments, such as property, private equity, and certain hedge funds, may offer higher returns but lack liquidity. If you need access to your funds in a downturn, selling these assets at a fair price could be challenging.
Liquidity constraints also apply to certain retirement products, such as living annuities and compulsory annuities. While these products provide a steady income, they generally do not allow for lump-sum withdrawals beyond regulated drawdown limits. If you require capital to fund major expenses like holidays, vehicle replacements, or home renovations, you will need to rely on discretionary investments. This makes it crucial to ensure you have enough liquid assets outside of retirement annuities to maintain financial flexibility. For retirees, maintaining sufficient liquidity is essential to cover living expenses and unexpected costs without being forced to sell investments at a loss.
2. Capital Adequacy Risk
Capital adequacy risk is the danger of not having enough invested capital to sustain your retirement needs. Even with a well-balanced portfolio, withdrawing too much too soon can deplete your assets faster than anticipated. This risk is particularly relevant in the early years of retirement when sequence-of-returns risk can have a significant impact. To mitigate this risk, retirees should work with a financial planner to determine a sustainable withdrawal strategy and ensure that their portfolio is designed to provide income for their entire retirement.
3. Inflation Risk
Inflation risk erodes the purchasing power of money over time. If your investment returns do not outpace inflation, your savings will buy less in the future. This is particularly concerning for retirees who rely on fixed income sources, such as pensions or annuities, that may not adjust for inflation. Investing in a diversified portfolio that includes assets with the potential for growth, such as shares and inflation-linked bonds, can help protect against this risk and ensure your retirement funds maintain their value over time.
Finding the Right Balance: Investment Returns for Retirement and Managing Risks
The key to successful retirement investing is finding the right balance between achieving the required return and managing the associated risks. Investors should consider:
• Diversification: Spreading investments across different asset classes to reduce exposure to any single risk.
• Risk Tolerance: Assessing how much volatility you can handle without making impulsive decisions.
• Investment Time Horizon: Aligning your investment strategy with the number of years you need your assets to last.
• Regular Reviews: Monitoring your investment performance and adjusting your strategy as needed to stay on track.
Further Reading: Understanding different types of investment risk and why volatility isn’t something to fear
Closing Remarks
Investment returns play a crucial role in determining financial security in retirement. Even a seemingly small difference in returns can have a significant impact over time. However, chasing higher returns without considering risks such as liquidity risk, capital adequacy risk, and inflation risk can jeopardise long-term financial stability.
At Henceforward, we make use of sophisticated cash flow modelling tools to help our clients understand the return they need to achieve a sound retirement. Our process starts with deep questions about the life you envision in your retirement years. We convert these aspirations into monetary terms to create a tailored financial roadmap. If we understand the lifestyle you are looking for and the assets you have available, we can mathematically determine the investment return you actually require.
Once we establish the required return, we can then have a meaningful conversation about the level of risk – particularly volatility risk – associated with the asset allocation needed to achieve those returns. Risk isn’t always as bad as it seems; rather, it is about finding the right balance between the risk you need to take, the risk you are comfortable taking, and the risk you can afford to take.
Do Read: How to construct an investment portfolio for your living annuity
Steven Hall
Steven is a Certified Financial Planner® and Partner at Henceforward. With over two decades of experience in wealth management and retirement planning, Steven specialises in helping individuals make smart, personalised investment decisions for long-term financial security. He’s passionate about turning complex financial concepts into clear, actionable advice that empowers clients to retire with confidence.
