Business Times

The retirement income conundrum Intelligent Investor

By Kajanga Kulatunga

The recent government announcement that senior citizens would receive a 20 % bonus interest on the standard deposit rate has caused a stir with accusations that it was a politically motivated election gimmick. Putting aside the politics, the current low interest rate environment has had a major impact on those who rely on savings to generate an income to survive.

The vast majority who fall in this category are senior citizens or recent retirees. While commendable on the part of administrators, a temporary bonus interest payment masks a long term risk to retirees not to mention the costs to other tax payers.

The low interest rate environment is damaging to investors primarily due to the lack of diversification within the average retirement portfolio. Legally there are only two types of investments available to investors. They can opt to lend money to companies, which is investing in bonds or place money in term deposits for the banks to do the same. Alternatively, they can choose to become a part owner of a company, or invest in shares. When investing in bonds, you are rewarded with a fixed payment at regular intervals. Share investors on the other hand gain access to both a dividend payment (your share of profits of the company) and the added chance of benefiting from rising share values. The reason that share investors don’t have any fixed payment coming to them is due to the changing fortunes inherent in owning any business.

Few Sri Lankans actively invest in shares, and when they do, it’s mostly for speculative reasons than long term wealth creation. Research from many global markets show that shares and other “growth” assets helps preserve and grow your capital over time. These assets help overcome the number one enemy of all retirees – inflation. Retirees globally make the mistake of putting money in term deposits based on current yield, when they may be looking at a retirement life span in excess of 30 years.

Investing in shares in Sri Lanka is no easy task. For one, there are no attractive investment funds which can be accessed at a low cost. Direct ownership of shares remains the most popular way of gaining access. Shares that pay and have a history of paying (with at least a 10 year track record) a growing dividend are ideally placed for a retiree. Globally, utilities companies and deregulated telecommunications companies offer some of the best prospects. Multinationals and owners of brands with near monopolistic pricing power also offer a good track record.

The record of Sri Lankan companies here is mixed. The dividend yield (total dividend paid for the year / share price) for the top 25 companies in the CSE has mostly been in single digit territories, even during periods when inflation was greater than 20 %. The dividend payment decision is one that is left to company management. Many Sri Lankan companies, and in fact emerging market companies, have low payout rates due to the difficulties in raising capital from alternative sources. However, the total return has been strong given the marked price appreciation in 2009.

But income isn't interchangeable; a 10% yield on your term deposit isn't the same thing as a 10% yield on shares. As the last two years clearly demonstrated, shares can fall hard even when they pay high dividends. Therefore the decision to include shares in a well diversified portfolio needs to be carefully accessed against your long term investment goals and tolerance for volatility.

Assuming there is no need for shares in your portfolio, one of the easiest ways for you to diversify your risk from falling interest rates is to invest in deposits across a range of time horizons with varying maturities. Put away capital you would not need for sometime, in longer term deposits (longer than 3 years). The rest can be spread across a range short to medium term deposits. That way you will not face the risk of reinvesting all your life savings at the same time, in a low interest rate environment. Such diversification may be important now than ever before, given the uncertain global financial environment we are entering.

It is natural to be anxious about the deposit rates if you depend on that income for survival. Whilst a bonus interest is better than none at all, you may have to indirectly support this policy through higher taxes on goods and services. Meanwhile recent news allowing you to invest money overseas provides a great opportunity to diversify and strengthen your retirement income. Diversification would help in the long run as opposed to being dependent and exposed to administrative policy risk.

(The writer is an Investment Specialist based in Sydney, Australia. He can be contacted via

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