(03) 9020 2905PORTFOLIO POINT: It’s time Australians and superannuation regulators understood exactly how long it is they’re going to live and have their super invested accordingly and appropriately.
There’s a deep psychological problem with the perception of superannuation in Australia. And that is the constant focus on retirement age.
Far too many Australians have in their mind that they will get to “spend their super”, or “access their super”, or “start to live it up with their super” from their birthdate-designated age of access (between 55 and 65 dependent on birthdate and employment circumstances). There is an inordinate focus on “age 65” – the latest age at which Australians have a restriction on the being able to get their grubby little hands on their super for their own benefit.
It is partly the fault of the lawmakers, the regulators, the media and the industry. And we should throw in a bit of human nature also. But there is a concentration on 65 being some magical age for superannuation that you strive for.
Purely and simply, it’s not.
It’s because of this unnatural fascination with age 65 that Australians can be over-conservative with their superannuation investments and that we have a one-size-fits-all “default” balanced investment profile for super fund members.
What this misses – as another interesting piece of research by Watson Wyatt has pointed out – is the risk of running out of money during your retirement because you haven’t invested aggressively enough. As a nation, we need to understand that “age 65” is the start of another phase of superannuation and one that is likely to run for more than 20 years, but quite likely 30 or 35 years.
Watson Wyatt’s recent paper is essentially a discussion of “lifecycle” investing. This is the notion that the younger you are, the more aggressively you should have your super invested (a higher proportion in shares and property). The closer you get to retirement age, the more of your assets should be shifted to lower-risk asset classes, such as cash and bonds.
At its core, the reasoning is that if you are too conservatively invested before, but particularly after, retirement age, you run a substantial risk of running out of money before they die. Watson Wyatt refers to this as the “risk of ruin”, or the chance that Australians will run out of money and be forced onto the government age pension (while not ruin, it’s pretty meagre).
The answer? According to Watson Wyatt, it’s a combination of getting super members to understand their risk profile and understand that they should invest a little more aggressively than with what they’d be perfectly comfortable with.
This exact point is something that I discuss particularly with all of my Generation X clients – the fact that superannuation is, for them, an almost infinitely long investment vehicle. (There are many definitions of Generation X, but mine is anyone born in the 1960s and 1970s.)
Take someone who is 37 years old now and this is what’s facing them. They’ve got at least 23 years until they’ll be able to touch their super (if the age of 60 isn’t lifted). They’ve got at least 30 years until they’ll be able to access the government age pension (if that isn’t lifted beyond 67). And they’ve got, approximately, 45 years until their date of death (a bit shorter for males, a bit longer for females and that’s only on the current life expectancies, which will likely get longer before they get there).
Not one of those time frames is “short”. Even 23 years is generally considered to be at least two, if not three, full investment cycles. But their superannuation is actually, on average, an investment that needs to run over the next 45 years. If you accept that higher growth assets (shares and property) perform better over the longer term than income assets (cash and fixed interest), the argument with Gen Xers is that they should take one step, perhaps two, beyond their normal “risk profiles” for their superannuation investments.
Watson Wyatt’s paper points out some of the longevity risks.
- Men are expected to live to 84 and women to 87 currently.
- There is a 73% chance that one of a couple will live to age 90.
- There is an approximately 8% chance that the male will live to 100.
- There is approximately a 12% chance that the female will live to 100.
- There is a 20% chance that at least one of them will live to age 100.
That means that there’s about a 50-50 chance that a couple’s retirement assets will need to last at least one of them until they are 95 years old. Assuming they don’t retire “early”, that is 30 years in retirement before the odds move towards both members of a couple being dead.
There are two general ways to improve your super’s own life span.
- Take less of a pension.
- Increase the amount in the pot.
Watson Wyatt’s models take the example of a couple at age 65 with a combined super balance of $500,000. The following graph is based on comparisons to a “balanced” investment portfolio, considered to be 70% growth and 30% income.
The graphs show the likelihood of being “ruined”, based on how aggressive your investment strategy is. (Clearly, modelling like this relies on an acceptance of shares and property outperforming cash and fixed interest.)
Probability of ruin with varying investment strategies
The next of Watson Wyatt’s graphs is even more interesting. It shows that a less aggressive investment approach will lessen your chance of ruin if you, or both of you, are likely to die prior to about 91. However, if you’re likely to live beyond that, the more aggressive the risk strategy, the less the risk you’ll run out of money.
Probability of ruin over time for varying investment strategies
Coincidentally, another interesting way of dealing with this potential issue comes in a submission to the Henry Tax Review from fund manager Challenger.
Challenger’s submission that at least 30% of all super should be taken as a lifetime or deferred annuity. This would, at worst, guarantee an income greater than the age pension for the rest of the pensioners life.
“Lifetime annuities eliminate the possibility of exhaustion of private retirement benefits, so retirees are guaranteed an income in excess of the Age Pension over the full course of their retirement,” Challenger’s submission said.
A further bonus, says Challenger, is that it would cut the cost of the pension by as much as 0.2 percentage points on a bill for the Federal Government of providing age pensions of 3.9 of gross domestic product.
Lessons to be learned
From a community basis, there needs to be more of a concerted effort from fund managers, the government, regulators and financial advisers on making the community understand the dangers of longevity risk (for more on this see an article I wrote on February 1, 2008).
Few people will have been comfortable with the capitulation of investment markets and the damage that caused super members over the last 18 months. However, it’s been a once-in-a-generation event. And as we know, what if you’d missed out on the rally since early March?
This is not an argument for people to rush out, ignore their own fears about risk, and punt the lot on shares and property. But it is an argument against becoming too conservative too soon. If anything, it is another argument in favour of being slightly more aggressively invested than you would feel ultimate comfort with.
Bruce Brammall is director of Castellan Financial Consulting and author of Debt Man Walking.