The "standard risk measure" developed by the superannuation industry to inform members of the risks inherent in their investment option may lead some to make choices that are not in their best interests.
The typical default investment option, where most people have their money, is rated "high risk" under the standard risk measure because it can be expected to have about six negative years during any 20-year period.
Under the standard risk measure each investment option is labelled from very low risk to very high risk according to the expected frequency of negative years in any 20-year period. The industry devised the standard after being prompted to do so by regulators.
Balanced investment options are heavily invested in shares. After the GFC, Australian super funds rank among the worst performers in the world. Regulators wanted the risks better flagged to members.
Over the very long term, balanced investment options have broadly met their performance and risk objectives. Data from researcher Chant West shows that the typical balanced option returned 7 per cent, on average, over the past 20 years and that inflation was 2.6 per cent. That means the typical balanced investment option produced a real return after inflation of 4.4 per cent.
That is better than their aim of beating inflation by between 3 percentage points to 4 percentage points. In the risk they took to get those returns they also met their targets, having only three negative financial years in the past 20 years. As Warren Chant, the co-founder of Chant West, points out, the negative years occurred in the past 11 of the 20 years.
That included not only the GFC but the "tech wreck" at the start of this century. Before that, in the previous nine years, not one year was negative and the lowest return in those nine years was 6 per cent.
But what is risky to one fund member is not to another. Industry fund AustralianSuper, worried that the standard risk measure would send the wrong signals to its members, added more information to help them make more informed choices.
Its approach recognises that different members have different objectives and face different risks. For example, a 25-year-old is likely to have different objectives to a 55-year-old approaching retirement. For older members the risk is they will be hit by losses and not have enough time to recover before retirement. Preserving capital is more important for them than 25 year olds, who focus on growing capital.
The table developed by AustralianSuper for its members shows the riskiness of the fund's balanced option, depending on how much time there is before retirement. For example, if fund members require their savings within the next five years, the balanced option is flagged high risk.
But if they don't need the money for at least 20 years, it is flagged as low risk.
The capital guaranteed option which, under the standard risk measure, is labelled as very low risk becomes high risk for the 25-year-old under its enhanced risk measure because the expected returns from the option will not generate sufficient returns to beat inflation. The returns in excess of inflation are important in saving for retirement. Fund members need their super to produce returns that will outpace the rise in living costs they will face by the time they retire.
The interesting conclusion from AustralianSuper's enhanced risk measure is that the risks for the 55-year-old in the balanced option are just as high as for the 25-year-old in the capital-guaranteed option - even though the risks facing the two differ.
Frequently Asked Questions about this Article…
What is the "standard risk measure" for superannuation and how does it rate investment options?
The standard risk measure, developed by the superannuation industry after a regulatory prompt, labels investment options from "very low" to "very high" risk based on the expected frequency of negative years in any 20‑year period. Under this measure the typical default (balanced) option is rated "high risk" because it can be expected to have about six negative years in a 20‑year period.
Why are balanced investment options often classed as high risk under the standard risk measure?
Balanced options are heavily invested in shares, which makes them more likely to experience negative years. The standard risk measure flags that higher share exposure can produce a higher number of negative years over a 20‑year window, which is why typical default balanced options are labelled "high risk."
How have typical balanced superannuation options performed over the past 20 years?
Research from Chant West cited in the article shows the typical balanced option returned an average 7% per year over the past 20 years, with inflation averaging 2.6% over the same period. That implies a real return after inflation of about 4.4%, which is better than the common target of beating inflation by 3–4 percentage points.
How many negative years did balanced options actually experience in the past 20 years?
According to Chant West data in the article, the typical balanced option had only three negative financial years in the past 20 years. Those negative years were concentrated in the most recent 11 of the 20 years and included downturns such as the global financial crisis and the early‑2000s tech wreck.
How does AustralianSuper’s enhanced risk information change how members see risk?
AustralianSuper added extra information to the standard risk measure to reflect members' different objectives and time horizons. Its table flags the same balanced option as high risk for members needing money within five years but as low risk for members who don’t need their savings for 20 years, making risk more personalised by time to retirement.
Why might a capital‑guaranteed option be considered high risk for a younger member?
The article explains that while a capital‑guaranteed option is labelled "very low risk" under the standard measure, AustralianSuper’s enhanced approach flags it as high risk for a 25‑year‑old because expected returns from that option may not be sufficient to beat inflation. Failing to outpace inflation is risky for long‑term retirement savings because it erodes purchasing power.
How should age and time until retirement influence my choice of superannuation investment option?
The piece stresses that different ages have different priorities: younger members (for example, 25‑year‑olds) typically prioritise growing capital and can tolerate short‑term negative years, while older members (for example, 55‑year‑olds) prioritise preserving capital because they have less time to recover from losses. AustralianSuper’s enhanced risk table illustrates how the same investment can be low risk for someone with a 20‑year horizon but high risk for someone needing their money within five years.
What practical steps can everyday investors take based on this article about risk measures and super funds?
Use the standard risk measure as a starting point but also look for funds that provide enhanced, time‑horizon‑aware information like AustralianSuper. Check how an option is likely to perform relative to inflation, consider your time to retirement and personal objectives, and choose an investment option that balances the need for growth with how much short‑term volatility you can tolerate.
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