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.