When superannuation is short on the long-term
Repeat after me: super is a long-term investment and I shouldn't worry about short-term market falls. Good advice it is too. Generally.
Repeat after me: super is a long-term investment and I shouldn't worry about short-term market falls. Good advice it is too. Generally. But there is a group of investors for whom this advice offers cold comfort. Retirees, and those nearing retirement, are relying on their savings to provide them with an income. They can think long term, but if their account balance falls, their short-term choices are limited. They can delay retirement or go back to work to try to rebuild their savings, but this isn't as easy - or desirable - as it sounds. They can try to get by on less, or they can continue to draw down their savings and wait for the markets to rebound.That last option sounds sensible, but the combination of income withdrawals and investment losses can make it difficult. In very simple terms, if a younger person has $500,000 in super and they lose 10 per cent, they still have $450,000 left. When markets recover, a gain of slightly more than 11 per cent will get them back to where they started.If a retiree has $500,000 and loses 10 per cent, they also have $450,000. But unlike those still saving, retirees need money to live on. If they are drawing down 6 per cent of their balance for income, that's a further $30,000 out of their kitty. And what about next year? They still need $30,000 to live on, but that means they're now drawing down more than 7 per cent of their remaining savings. They will need to earn a lot more than 11 per cent to get back on track for their full retirement.The Sydney practice leader with consulting firm Milliman, Wade Matterson, describes the combination of drawing down income and negative returns as "toxic" for retirement savings. He says short-term returns can have a significant effect on those in the retirement "hot zone".In a research paper on risk in retirement, Milliman said the risk of running out of money in 20 years increased from one in 10 under normal market conditions to one in two if a 65-year-old had started drawing down a pension in the past financial year and had a portfolio that was 70 per cent invested in shares.That's probably more aggressive than most retirement portfolios, but it clearly shows the big effect early losses can make.In practice, there are several ways retirees try to avoid this problem. One popular strategy is to hold two to three years' income in cash so they don't have to sell investments at a loss to draw down their income. Hopefully, the remainder of their savings has time to recover before further drawdowns are needed.Another option is to avoid losses by investing more conservatively - eschewing growth investments for fixed interest and cash. But even for retirees, super should be a long-term investment. Thanks to increased longevity, a retiree of 65 still has another 15 or 20 years (more if they live longer than average) to fund. They need a decent rate of return to stretch their money through retirement and growth assets provide better long-term returns.Avoiding the sharemarket while still chasing high returns makes retirees easy prey for dodgy investment schemes.You could try to solve the problem by buying a guaranteed retirement annuity instead of a pension that goes up and down with the market. But there are good reasons such annuities are not popular in Australia. They're inflexible, you give up access to your capital and the income provided is low compared with that from other retirement products. Matterson believes the Australian market is ripe for the development of new retirement products. He says products providing a lifetime guaranteed minimum withdrawal benefit are widely used in North America and Japan. He says about $1.5 trillion is invested in versions of guaranteed products in North America and about $US110 billion ($117.5 billion) is invested in Japan. The idea is that retirees pay a fee to be guaranteed a minimum income for the life of their retirement product. Matterson says the guarantee would be an overlay on existing retirement pension products. Ideally, you would just tick a box to activate it and pay the cost. The guarantee provider would use hedging to protect the retiree's income from market downturns, and the guarantee could also be expanded to cover other risks such as living longer than expected. Matterson says the products used overseas are more sophisticated than traditional capital guaranteed products, which often rely on switching to cash or fixed interest when markets are falling.He claims that with this style of guarantee, retirees would be able to be more aggressive with their retirement investments. Because their base income was guaranteed, they could structure their portfolios for the long term without worrying about the effect of short-term losses on their income. They could be true long-term investors.He says retirees would be looking at a cost of about 0.75 per cent a year for a guarantee offered through the industry super fund environment, and about 1 per cent or more with retail funds which have different cost structures. The costs and features of the guarantees would be tailored to the local market.Some institutions are already getting on board. Last year Axa launched its North protected growth guarantee option, which protects against market losses, and Asteron has a longevity pension that stashes money away in case you live longer than expected. But for the most part, retirees take their chances and hope all comes well in the end. With the baby boomers fast entering the retirement market, that status quo won't go unchallenged. They will demand retirement products that look after their needs both now and for the long term.
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