We receive many questions about superannuation caps, so thought it may be helpful to clarify the caps for this financial year.
Most of us have something in life that we’re absolutely passionate about. For some people it’s cars or boats, for others luxury is a beautiful home or a beachside getaway. For many people it’s about experiences like being able to go to the theatre or the symphony, or to travel and experience different countries and cultures.
Whatever your passion, and whatever your income, the key to affording more of life’s luxuries is to splurge wisely. Our mantra is to reduce your spending on the things you care little about so that you have more money to spend on things you do care about.
Here’s a few ideas on how.
Asset allocation is a blend of art and science. You will find that there are no immutable laws to tell you the proportion of equities, property, bonds and cash that you should hold in your portfolio.
Now, you may have heard some rules of thumb (“make your bond allocation equal to your age” is a popular one), but there are so many exceptions to the rule that they really are not helpful for most investors. At the end of the day, your asset allocation decisions come down to your comfort with the balancing act of risk and expected returns.
Larry Swedroe, who writes the Wise Investing blog at CBS MoneyWatch frames it well. He says that asset allocation decisions should be based on your “ability, willingness and need to take risk”.
The ability to take risk
Your ability to take risk depends on several factors: your investment horizon, the stability of your income (or human capital) and your other sources of income. For example, a 35 year old manager is unlikely to tap into her super savings for another 25 to 30 years, so can keep a large proportion of her portfolio in equities and other growth assets. Equally, a 60 year old senior public servant with a healthy defined benefit pension scheme, can also keep a large portion of his portfolio in shares. On the other hand, if you’re a 60 year old executive with five years until retirement, or a 35 year old entrepreneur, we would suggest that you may want to hold a greater proportion of fixed interest investments.
The willingness to take risk
How will you respond when your portfolio loses value, as it inevitably will? The answer will shape how much of your portfolio you should hold in growth assets like equities.
Your willingness to take risk depends on a range of factors: your value around financial security and stability, your psychological makeup, the amount of money you are investing and your experience with investor.
We talk to clients about their willingness to take risk in terms of how much in dollar terms they are prepared to see their portfolio fall (on paper) without panicking. Would it take a one-third loss before you panic? If you have a million dollars, that’s a $330,000 drop. Or would just 10% – $100,000 loss – give you ulcers?
The need to take risk
Finally, all investors should consider their need to take risk. If you need a 7% year return for the next 15 years to retire comfortably, then you’ll need a significant allocation (around 60%) to growth assets. If you’ve reached your target and have enough money to meet all of your financial goals, you might forgo all market risk – regardless of whether you’ve got 15 months or 15 years time horizon.
What is the lesson for investors?
So what is the lesson for investors? There are a couple.
First, don’t make the mistake of investing more aggressively than you are able, willing, or need. Many super default funds, although they’re called ‘balanced’ have more than 70% of their asset allocation in growth assets. In a major downturn, that could mean a 35% to 40% capital loss.
Second, asset allocation is not “set and forget”. The behaviour of asset classes changes over time – for example, in the past five years we have experienced unusually low market volatility. And your own circumstances, ability and willingness to take risk may also change over time.
Now is a good time to re-frame your investment strategy. This is because we are in a period of low volatility and positive returns – which means you are more likely to be feeling calm and rational. So if you’ve been procrastinating about dumping your high-cost active funds, investing that idle cash, or adjusting your asset allocation to keep it in line with your goals, then now might be a good time to do that.
Because when a storm hits again—and it will, though no one knows when—any changes you make are likely to be based on fear and emotion. And we all know how that works out, don’t we?
There has been an incredible amount of research in the past 50 years on how financial markets work – concepts like the risk-return trade-off, the theory of interest, the efficient markets hypothesis – that has led to more sophisticated approaches to capturing equity premiums for investors.
Think of it like how cameras have advanced in recent years. The advances in financial markets science are like the ability to capture images with much greater precision and clarity.
The latest research is on profitability – and how we can identify stocks with higher expected profitability in the market. In terms of investment outcomes, adding profitability considerations to existing strategies can generate a better expected return with lower volatility and greater reliability.
Could you be overestimating the lump sum you need to maintain a comfortable lifestyle in retirement?
New research, “Estimating the True Cost of Retirement”, suggests that your spending actually decreases gradually year on year. And yes there is an increase in the final phase of our lives with additional health care costs, as you would imagine. Yet, even this is not enough to offset the fall in spending in our last phase of life.
And that’s why the research so beautifully refers to our likely retirement spending as a smile.
Spending trends in retirement
The traditional assumption when it comes to retirement is that our expenditure will look like a straight line. Many of us expect that we will have higher activity expenses in the earlier years, and while these may decline, we are likely to have higher health and medical expenses in the later years.
Yet this new research asks us to think a little more deeply.
Perhaps take a moment to consider individuals and couples you know who are retired – they could be friends, family members, your own parents.
There will no doubt be a group who have recently “hung up their boots” who are very active. I can think of clients who have recently enjoyed 12 months traveling through the US and Europe, another has just returned from an extended sojourn in Spain, one couple has sailed up the east coast of Australia and is now in the process of buying a country property that they plan to renovate. And one inspiring client who on retirement immediately enrolled in art school to complete his Fine Arts degree.
And then, you can probably think of a group of retirees who’ve started to wind back a little from all that activity. They still enjoy golf, theatre, dining out, gardening – just that the level of activity has slowed. One of our clients is currently touring through Canada on what she has described as her last long haul trip. Another just wants to slow down and enjoy time with her children and grandchildren.
Finally, you would no doubt see a group who’ve slowed down significantly. Many of our clients’ parents are in this category. They still enjoy occasional outings, but their health and energy is not what it used to be. As a result, their consumption typically reduces to their day-to-day needs.
With those images in mind, the assumption that we will maintain a consistent level of spending is perhaps not what we experience at all.
So what does the data show?
The data in this recent study show not only a “curve” to retirement spending (rather than just a flat or declining line), but that retirees actually decrease their real retirement spending throughout almost all of their retirement. The rate of decline identified was approximately 1% per year, accelerating to 2% per year through the middle years, and then in the latter years reverting back to 1% per year declines again – with this reversion giving us the uptick of the smile.
What’s important is that spending remains below the starting point throughout the entire retirement period. So even with the anticipated increase in health care in our latter years of retirement, this is not sufficient to offset the decrease in other discretionary spending.
However, a note of caution. The retirement smile only results where retirees match their spending reasonably to their household net worth – either because they are high-spenders with a high net worth, or more conservative spenders with a lower net worth. The results are not contented for those who spend beyond their means. That experience looks more like a jagged cliff.
If you would like to have an improved estimate of the amount of money you need for retirement, we can assist with modeling that reflects the findings in this research. Simply call or email. We would be delighted to help.
Research undertaken by David Blanchett of Morningstar. With thanks to Michael Kitces in Portfolio Construction Forum (26 May 2014) for source information for this piece.
Not if you want to create financial independence, in our view.
And it’s a view shared by other financial experts it seems.
Read more in this excerpt from an excellent article by Debra Cleveland in the Australian Financial Review (6 June 2014) on the thorny question of how best to help your kids with a head start.
The good news in this Federal Budget is the absence of changes to superannuation. Instead, the focus appears is more on clamping down on welfare, with cuts to benefits for middle Australia. Reforms to the Age Pension, as promised by the Government, have been delayed until the next parliamentary term.
We have highlighted below the key changes proposed to taxation, superannuation and social security.
With just a few weeks to 30 June, have you prepared financial year end? What changes do you need to know about? And what opportunities can you take advantage of? Here are 18 tips for things you could do to potentially improve your wealth before 30 June.
It seems many people, like our dinner party guests, have been disappointed with advice. And many are hoping that the Financial Advice reforms, known as FOFA, will fulfil their goals of improving the quality of advice and tackle conflicts of interest for investors.
However, while the reforms require advisers to act in the client’s best interests, and remove product commissions (except on insurance) there are some gaps.
Here’s what we shared with our guests.
How much do super fund fees affect retirement income? The short answer: A lot.
Most investors could be losing 4 to 7 years of their retirement income to fees, according to our analysis. What would that mean to your retirement plans?
Many individuals have their super in their employer’s default fund. And if you’re like most people, you have collected several funds as you have progressed through your career.
However, few people have considered the importance of the critical factor of fees in determining whether they will achieve the ultimate goal of their super – to retire when they wish with sufficient money for a comfortable life.
What are typical super fund fees?