I came across an interesting article recently about the Norwegian Oil Fund, the largest sovereign wealth fund on the planet.
The Norwegians certainly showed admirable foresight in setting up the fund after oil was discovered in the North Sea in 1969, according to the article, which summarizes a talk given by Anton Mork, an economics professor at the Norwegian University of Science and Technology.
Rather than feed oil revenue directly into the treasury, Norway decided to set up the fund to preserve the wealth for future generations.
The fund has grown spectacularly since taking its first deposit in 1996, reaching the equivalent of over US$1 trillion. This reflects the wisdom of the fund’s investment policy. It features, for example, an open asset management process, the use mainly of index funds and ethical considerations such as avoiding coal and tobacco.
However, what really caught my eye is the challenges the Norwegians face in managing the wealth that has built up in the fund. What may surprise you is that these challenges are similar to those faced by many individual investors managing their retirement nest egg.
A central issue for both the Norwegians and individual savers is how to generate a constant stream of income from a fund that holds volatile assets. In the case of the Norwegian Oil Fund, the annual payout is set at the fund’s expected return after inflation, which since 2003 has been set at 3%.
To maintain this payout rate, while preserving the principal for future generations, the fund’s allocation to equity (including real estate investments) has risen to 70%. The pressure to maintain a constant payout is coming from the Norwegian government where 15% of spending is currently paid for by money from the fund.
“Inevitably, there is a tension between payout consistency, payout level, asset allocation and the ability to preserve the real value of assets for the benefit of future generations,” the article says.
There are clear parallels between the fund’s situation and that of individuals who are either approaching or already in retirement. Individuals have answer two questions:
- How do I prudently invest my savings to maximize growth while avoiding undue loss of principal?
- How much can I safely withdraw each year from my savings to fund my retirement while avoiding the possibility of running out of money?
These are complex questions and answering them is where your investment advisor plays a critical role. At PWL, the best time to discuss them is when we’re agreeing each year on your personal investment policy statement (IPS).
Your IPS establishes how much risk you will take in your portfolio to achieve your goals. We do this by agreeing to your target asset allocation—the mix of equities and fixed asset securities. For retirees, this is also the time to discuss withdrawals from your savings.
It’s a discussion that should be grounded in your practical realities. How much savings do you have? What are your cash flow needs? How volatile is your income and how much volatility you can accept?
At PWL Capital, we’ve signed an IPS with all our clients since the founding of the firm over 20 years ago. It’s an essential tool for making the right decisions for your financial well-being now and in the future.