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That's because when you consider the five-year rate on a typical annuity or term deposit of about 3.15%, a retiree couple fully invested in such products will need at least $1.85¹ million to live comfortably, based on the ASFA retirement standard of $58,444².

For those with a more modest nest egg the simple way to retire comfortably would be to invest in higher income strategies, but for advisers meeting with risk-averse retiree clients, that may be easier said than done.

For example an adviser may have a client unwilling to move from term deposits, fearing capital loss. Whether this is really a safe investment depends on which side of the return ledger the client focuses on.

Since their most recent peak in July 2008, term deposits have provided stable capital on the one hand, but on the income side they have suffered a 70% drawdown as one-year rates have nosedived from 8.25% to 2.55%, according to the RBA. To put this into context, this income loss dwarfs the biggest ever fall in the Australian sharemarket - 54% during the GFC - and this ignores the fast recovery of shares and a franking boost. Furthermore, if you strip away share price volatility, the biggest decline in the income from the sharemarket index has been 20%.

Who would've thought term deposits could be over three times more risky than share dividends when it comes to income drawdown? Sure, equity prices are more volatile, but the point is how many retirees would appropriately consider both sides of this risk equation?

Annuities, which are generally perceived as a secure retirement investment, have not escaped the impact of falling official interest rates. A retiree in a 5-year annuity today can expect to receive a total return of about 3.15% (assuming full capital preservation), which is marginally higher than a five-year term deposit (about 3.1%).

What is perceived as secure income in the short term may turn out to be significant interest rate risk exposure in the long term. Income risk remains, it's just harder to see when it's held up until the investor rolls into the next fixed term.

So the bigger question then becomes, is a safe retiree investment about capital preservation, income generation, or both?

It seems when sharemarkets fall, the pendulum shifts towards capital preservation and when interest rates fall the opposite holds true. Not surprisingly, optimising this balance may simply involve an allocation between fixed income (including term deposits and annuities), real assets and equities paying solid dividends.

Legg Mason and Martin Currie Australia (a Legg Mason fund manager) identify three buckets that define the retirement income spectrum:

1: Fixed Income and cash: Low capital volatility

This includes a range of investments that offer a defined income stream such as term deposits and annuities. This group has been considered the safe house for retirement income particularly since the GFC. Capital may be protected (subject to the issuer not defaulting) and the income may be defined for a term, but not beyond that term.

In this category are also bond funds which tend to be more diversified in their portfolios and offer greater liquidity, with the potential for higher income, although variability in income and capital are the main trade-offs.

2: Real Assets: Inflation protection

Real assets can act as the 'inflation protection' bucket of the retiree portfolio.

Martin Currie Australia define real assets based on what's included in their Real Income Strategy: listed property, infrastructure and utilities. This combination has been successful in delivering a 12-month return of 19.4% for the Legg Mason Martin Currie Real Income Fund (after fees).

For advisers, the benefits of real assets in client portfolios is that they can provide natural inflation protection, so income is expected to go up, not down. For example, toll companies fit into this category and they have contracts in place to increase pricing each year - that may take a little more out the pocket of drivers each year but it offers tremendous value if you are on the shareholder side.

3: Equity Income: Income Growth

Equity income funds rely on the dividends of ASX-listed companies to generate income that can grow perhaps faster than any other domestic asset class. The key message for advisers to communicate to clients is that the volatility of dividends is not the same as shareprice volatility, which is why equity income funds are more suited to retirees. For the five years to May 2015, dividend volatility has been 3.4%, far lower than shareprice volatility of 9.7%.

Some equity income funds offer protection strategies, often through options. The Legg Mason Martin Currie Equity Income Trust does not invest in derivatives or provide a protection overlay, based on the philosophy that the best way to grow income faster than inflation will be in the form of straight dividends paid by the highest quality companies. The most efficient and cost-effective protection mechanism for investors is to blend equity income with other asset classes like fixed income that can provide a more 'natural' hedge. Using a protected equity income fund in a multi-sector portfolio may be like buying two sets of insurance on the same car, and that may ultimately impact returns.

4: Blended solution:  Multi-asset 

A blend of the three buckets in a multi-asset fund may be most appealing to retirees that want to step away from term deposits and increase their income potential.

Legg Mason's multi-asset approach invests in an equal blend of fixed income, real income and equity income. That way, retirees get the expected benefits of low volatility (fixed income), inflation protection (real assets) and income growth (equity income).

In 2014 Legg Mason and Martin Currie Australia jointly launched a Multi-Asset Retirement Income Trust (MARIT) that is the first of its type in Australia. MARIT is not a typical multi-asset fund: it includes a unique combination of real assets and its equity component is managed from a retiree perspective rather than an accumulator. It's built for retirees.

The fixed income component is managed by Western Asset, one of the largest active fixed income managers globally.

In the year to June 2015 MARIT has returned an impressive 12.2% (after fees).

According to independent consulting firm Rice Warner, a 'comfortable' level of retirement income until at least life expectancy is expected to be achieved with as little as $440,000 invested in the Legg Mason Multi Asset Retirement Income Trust. This figure assumes the member is a single home owner and has an initial drawdown rate of 5.8% of the initial balance, indexed to inflation and includes age pension entitlements which are additional to the drawdown.¹

For further information on Legg Mason's multi asset retirement income solution, click here.

Retirement's most innovative

Legg Mason, 2015 Fund Manager of the Year at the recent Lonsec/Money Management Fund Manager Awards, has been among industry pioneers in developing equity income in 2010, a unique real income strategy in 2011, and a multi asset retirement income capability in 2014 - all built with retirees in mind.

Investment Strategy

Legg Mason is hosting a Retirement Income Symposium in Sydney on 16 September that will explore many of the issues above and include independent external speakers. It's free to attend and CPD points will be awarded. Please click here to register you interest.

1 Lump sum calculation assumes no drawdown of capital and is maintained in nominal terms over retirement. The amount does not take into account eventual receipt of Age Pension as the super balance run down.  

2 Based on the ASFA (Association of Superannuation Funds Australia Ltd) Retirement Standard.

3 Source: Rice Warner. The modelling includes age pension entitlements which are additional to the drawdown. Modelling also based a single member, and the result indicates that if a single female member spends the ASFA comfortable retirement amount of $42,433 a year, she would need an initial balance of about $440,000 (with a drawdown rate of about 5.8%), for her money to last to life expectancy on average, if she is invested in the MARIT. 

Any reference to "Legg Mason Australia" or "Martin Currie Australia" is a reference to Legg Mason Asset Management Australia Limited ABN 76 004 835 849 AFSL 240827. Martin Currie Australia is a division of Legg Mason Asset Management Australian Limited. Any reference to "Western" is a reference to Western Asset Management Company. Neither Legg Mason Australia, nor any of its related parties, guarantee the repayment of capital or performance of any of the trusts referred to in this document. Past performance is no guarantee of future performance. Applications to invest in a Legg Mason Trust can be made using an application form comprising part of the current Product Disclosure Statement, which is available from our offices or on our website at www.leggmason.com.au. Certain eligibility criteria applies. Legg Mason Australia does not guarantee the accuracy or completeness of this document. To the extent permissible by law, Legg Mason Australia accepts no liability in contract, tort (including negligence) or otherwise for any loss or damage suffered as a result of reliance on this document. This document does not constitute investment advice, and has not been prepared to take into account the investment objectives, financial objectives or particular needs of any particular person. Before making an investment decision you should read the Product Disclosure Statement carefully and you need to consider, with or without the assistance of a financial advisor, whether such an investment is appropriate in light of your particular investment needs, objectives and financial circumstances.