Getting the right investment balance in retirement
By Alexandra Cain
This article first appeared in the Sydney Morning Herald
Interest rates in Australia have reached historic lows, with the Reserve Bank of Australia lowering the cash rate to an unprecedented low of one per cent in July this year.
This has flow-on effects to assets that are traditionally considered safe, such as term deposits, which pre-retirees and retirees have traditionally used to generate income.
While in past years older Australians were able to earn a return of up to seven per cent from defensive assets such as term deposits, that's now near impossible. As a result, many are searching for assets that can produce sufficient income to support them after they leave work in addition to relying on their superannuation to fund their lifestyle.
"Investing in term deposits may be a safe way to preserve your retirement savings. But in the current climate they won't help you to grow your capital. Term deposits currently earn interest rates of about 1.8 per cent. It can be very difficult for retirees to sustain their lifestyle if all their funds are invested in defensive assets like term deposits," says John Owen, a portfolio specialist with MLC.
Benefits of investing in Australian company shares
At the moment, according to Owen, investors generate a better return investing in the shares of Australian companies than term deposits. These assets pay a healthy dividend yield, and also offer franking credits, which term deposits do not.
"Investment-grade or government bonds are also defensive assets that can be considered as safe investments. But again, yields are very low," he explains.
Investing in governments bonds
Australian government bonds with a 10-year maturity are generating yields of about 0.95 per cent at the moment, while US government bonds with the same maturity profile are generating a return of about 1.56 per cent.
Says Owen: "These assets are typically safe if you hold them to maturity. But the running yield at the moment is low, just like term deposits."
Ensure your investment strategy is appropriate for your stage of life
In this environment, diversified managed funds may offer investors the opportunity to generate capital growth and also income. But, says Owen, it's important to seek advice to ensure your investment strategy is appropriate for your stage of life and aspirations in retirement.
"There are many ways to structure investments so they produce income and also ensure the funds will last as long as possible," he says.
This is important given life expectancy is rising. According to the Australian Institute of Health and Welfare, a boy born between 2015 and 2017 can expect to live to 80.5 years and a girl could be expected to live to 84.6 years. In contrast, those born between 1881 and 1890 would have lived some 30 years less.
"People are leading longer, healthier lives. So, our money has to last a lot longer than in the past," says Owen.
Investing in growth assets after 55
This is another reason why it can make sense to invest in growth assets, even as we age. Growth assets such as shares typically generate a higher return over time compared to defensive assets such as term deposits and bonds. Nevertheless, the allocation to growth assets typically reduces as we age, to reduce risk.
Most Australians in the workforce typically have their superannuation invested in what is called a 'default' super fund chosen by their employer. "The default investment strategy for people who are aged 55 and under is usually a growth strategy. This means up to 80-90 per cent of the assets in the portfolio are invested in higher risk growth assets like shares and property and only 15 per cent are invested in assets with more defensive characteristics."
"The reason why that's appropriate is because they have time on their side. Younger investors can ride out the peaks and troughs in the market cycle because they've got a long time before they will access their superannuation. So, a higher risk strategy is probably appropriate for those sorts of investors," he explains.
It's usual to reduce investment risk for members in the default portfolio who are older than 55 and approaching retirement. Their default super fund may allocate more of their funds to lower risk assets.
"By the time they reach retirement age of 65, with progressive de-risking, they may end up with a portfolio that has around 70 per cent allocation to growth assets and a 30 per cent allocation to defensive assets. Having a lower exposure to growth assets at that stage of life is appropriate because they are more vulnerable to market corrections the closer they get to retirement," says Owen.
Managed funds have different approaches to risk
It's important to recognise, however, different managed funds have different approaches to risk. So remember to check how your fund changes its approach to risk as members age.
This will help ensure you get the balance right between defensive and growth assets, so that your assets are generating some income as you age, but you're not exposed to too much risk.
That's one of the best ways to ensure you can live the life you want in retirement and at the same time ensure you have enough money to live on until the end of your life.
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