PORTFOLIO POINT: Investors should be reviewing the amount they have in superannuation – and the size of their equity holdings.
The tradition in the stockbroking and institutional world is that every Christmas and New Year they forecast a stockmarket rise of 10–20%, irrespective of what has happened in the past.
That means everyone who has large amounts of equity in their superannuation fund, or who has big equity holdings in their private investments feels good, and spends up big over the festive season.
If the broker or institution forecasts a fall in the market they are accused of not getting their clients completely out. It is a stupid game and I don’t propose to join in, although at the end of this commentary I will remind readers of the need to beware of a nasty global downturn.
Sharemarket volatility has brought the message home to a vast number of Australians that they do not have enough money set aside for their retirement.
When they were gaining 7–10% a year on stockmarket investments there seemed no particular need to have vast sums for retirement because what they had already was yielding good returns. Now those returns have evaporated and people from all walks of life are looking at how much super they need.
Those that retired earlier, believing they had enough put away, have had to cut back their spending: not a pleasant experience. If you are approaching retirement, the first question you must ask is “what lifestyle/expenditure patterns do I wish to pursue in my retirement?”.
If you have a very frugal lifestyle then it is possible to live on the pension, but very few baby boomers or their children have the skills necessary to do that. Their parents and/or grandparents had those skills because they lived through the Depression and two world wars.
And so if you undertake some simple sums and say your return from superannuation is, say, 5%, that means a $500,000 fund will only yield $25,000 a year, albeit tax-free because you will have put the fund into pension mode, which is possible once you turn 60.
A large number of Australians couldn’t live on that and if they dip into their capital their situation would get worse. A million-dollar lump sum would produce $50,000 a year, which some could live on. I have written previously that to retire comfortably you need more than $1 million, and many people will need double that.
The problem is that whereas in previous generations it would be possible to put vast sums of tax-deductible money into your super in your later working years, you can now only contribute $25,000 (unless your fund balance is less than $500,000) so you may need to take advantage of the $150,000 entitlement to invest tax-paid funds into superannuation.
That is a total of $175,000 a year, of which only $25,000 is tax-deductible. That’s what I do and I regard the $150,000 as an entitlement. Life expectancy used to be much lower, but a larger number of people will now live to 90 and beyond, so unless you have very large sums in your retirement funds or are prepared (and able to) to live on a low income, you will need to keep working.
When I hear of people retiring at 60 and 65 I am usually not bold enough to ask them how much money they have, but my guess is that very few have sufficient wealth and are simply saying “let’s enjoy our money because we might die”. The problem arises when they don’t die. Those who have strong savings will look at helping with their grandchildren’s education but be careful about doing this if your savings are too low.
What about our grown-up children? If young people want to accumulate large sums in superannuation that is tax-deductible they need to start saving much earlier than people of my generation. Young people can’t do that because they have enormous mortgages, which they will spend almost all their working life paying off.
Many people now say that the way around this is to rent a house. For long periods of time when house prices are static or falling this looks a good strategy. But every so often house prices jump and if you are not on the housing escalator your finances can be left behind. In a flexible workforce that can cause timing problems.
I ran into a couple during at a recent drinks party who had bought a house in rural NSW where the male spouse was working. Somewhat unexpectedly they moved south to regional Victoria and now want to sell the NSW house but find they are likely to incur a loss. This is not a pleasant experience.
More Australians will need to be mobile and the idea of protecting yourself from house prices price by buying a leveraged house in your superannuation fund and then renting it is one that a great number of people will look at much more closely in the years ahead. A couple can pay a house off with tax-deductible money. (For more on this, click here.)
A great many Australians (happily, a smaller proportion of Eureka Report subscribers) have more of their wealth in the sharemarket than is good for them. Financial planners got big commissions and superannuation institutions loved the market power, so investors were herded into equities.
It will take a decade to recover from the shock of the past two or three years. It is important for all young people to set up their own funds. The big institutional funds are deservedly in decline; they have already lost 30% of the market to self-managed funds, and in the next few years self-managed funds will account for up to 50% of Australia’s superannuation. Among their attractions is that a self-managed fund offers the flexibility of owning real estate in your fund, although you cannot rent it yourself or buy it from yourself.
One of the reasons the institutions have served superannuation people badly is that they have not focused on individual customer needs, and this year we saw the terrible short-term decisions they made. They sold out ConnectEast, which was a perfect inflation hedge for long-term savers; they didn’t bother to do any serious study of AXA and sold out the Asian business to the French at a fraction of its worth; and they didn’t do sufficient work on Foster’s, although the market timing might be good. These are profound mistakes that are going to affect the savings patterns of our nation.
Finally, I have always thought that some way, somehow, Europe would overcome its problems but the politicians seem unable to grasp that they have both a sovereign debt and a banking problem and both must be tackled. And as each month goes by with half-measures, the problems get deeper.
We are looking at the real possibility of a global credit squeeze and Australia will be affected because our banks depend on wholesale overseas borrowings and there has been strong investment by European banks in Australia, which they will now want to dispose of.
There is no certainty that this will happen, but it is important that Eureka Report readers make sure they are not heading into this crisis with a large amount of short-term borrowing; if you have borrowings from the bank to fund your business make sure they are well documented.
Verbal banking agreements are no protection in a squeeze. In tough times, interest rates normally fall but if the European banking situation gets worse they could rise and so could create a pretty nasty situation.
I am not forecasting that this will happen but I can certainly see the danger. What I have done is to make sure that while I have exposure to the upside I will protect most of my capital in these difficult times. In Australia, bank deposits are good, remembering that if they under $250,000 they are government-guaranteed.
I’m taking a summer break so this will be my last comment for 2011. I am looking forward to being back in 2012.