How to Boost Your Retirement Income

By the time you read this, the S&P/ASX 200 may have already crested 4,000. What a rally. Just when everyone thought it was out of steam, the market has gotten a boost from some of that cash we mentioned late last week.

It was a throwback kind of day in New York, with Intel up over 7% on better-than-expected earnings figures and a positive outlook on PC demand. In fact the S&P 500 is up over 6.1% for the week. If Aussie stocks conform to the pattern, they should close the day up around the same amount for the last four days.

First Goldman leads a rally. Then Intel. It’s like a parade of credit bubbles being inducted in the credit bubble hall of fame. Enjoy the spectacle it for as long as it lasts. But be wary.

Yesterday we gave incoming IFSA boss John Brogden a serve for advocating an increase in mandatory super from 9% to 12%. In fairness, we should point that IFSA has released a new charter (not yet approved by member) that would phase out inbuilt commissions on managed funds starting in July of 2010. That’s a good start in realigning the interests of your super fund with your own financial interest.

But we’re still not convinced it solves the problem of creating a reliable retirement income from your actively managed funds. Brogden told the Australian Financial Review that, “Increasing the superannuation guarantee levy is strong on the agenda; we’re very clear that we need to boost retirement incomes.”

Though Kris Sayce is the Old Hat Factory’s resident expert on super, as far as we can tell, the “superannuation guarantee levy” merely guarantees that 9% of your wages are confiscated before you get a chance to even touch, smell, or taste them.

Of course everyone is told that super is an addition to base salary. But in actual fact, it makes up part of your total compensation. And as such, we’d suggest that the current system effectively prevents you from using this money the way you see fit. It denies you control of your own property, presumably because you are too stupid to look out for your own interests.

Can funds really look out for your interest? Well, even though, as we pointed out last week, actively managed funds, ON AVERAGE, underperform the market, there are some fund managers that DO beat the market. And they are worth paying attention to, not so much because you want to buy the funds. This is a common mistake. Last year’s best funds are almost statistically destined to underperform this year’s winners.

No. The main reason you want to study the actively managed funds is to see what’s working and see if you can imitate it, or find something worth imitating. For example, the best-performing long-only share fund of the last 12 months is Tim Samway’s Hyperion Australian Growth Fund.

“The key to outperforming in an economic downturn is to buy stocks that generate cash flows independent of consumer spending,” Samway told the AFR. “We buy stocks that produce organic growth by rolling out a business model, rather than relying on the consumer to come back,” he added. Sounds pretty sensible in a Great Recession, doesn’t it?

More importantly, cash flow is something you can measure. You don’t have to guess. And-as the inaugural issue of Kris Sayce’s new Australian Wealth Gameplan shows, there are some Australian industries that continue to generate healthy cash flows no matter what the rest of the economy does. For income-minded investors, buying these stocks at bargain prices is the closest thing you’ll get to a second income from the stock market.

The only real weakness to Hyperion’s case is that it’s a long-only stock fund trying to make hay during a bear market. Thus, even though it’s the best performing fund of the last twelve months, it’s down one percent. In relative terms, that’s great. In absolute terms, it’s down one percent.

This highlights a basic problem with just having your money unceremoniously dumped into super funds that are overweight equities or placed with long-only fund managers who HAVE to be in the market. This kind of asset allocation (biased toward stocks) doesn’t really take advantage of the options that super makes available.

But you’d only know of those options -and exercise them-if you were actively seeking the best way to manage your entire portfolio of assets, in order to generate both income and safety. These are the questions Kris is taking up with a handful of various experts from around Australia in his new publication. You can’t buy it just yet. But stay tuned next week for more news.

Incidentally, the best way to generate a second income is probably to own your own business. That’s also-in our opinion-the most likely way to build wealth.

One way to NOT build wealth is to borrow. And as you know, Australia is set to borrow up to $300 billion in the next few years to finance its growing deficits. Some think this is the proper role of government. Others think it is madness. But one non-political question is whether the government will actually be able to borrow that money at all.

An article in Wednesday’s AFR raised the possibility that an Australian government bond auction could fail this year. The auctions are being conducted on an almost weekly basis by the Australian Office of Financial Management (AOFM). “The poor performance of two bond auction tenders in mid-June has cast a shadow over the AOFM’s issuance program and prompted speculation that an auction may fail in the next year.”

Before we get to what the consequences of a failed bond auction might be, let’s look at the data we compiled from the AOFM site. We’ve compiled the results from the last nine auctions, dating back to June 3rd. By the way, there’s another one tomorrow! Included are the date, the amount raised, the average yield, the maturity date of the offering, and the coverage ratio.

By the way, the coverage ratio is important because it shows you the appetite for government debt. The AOFM defines the coverage ratio as, “The ratio of the total amount of bids received to the amount on offer at a tender for the issue of Commonwealth Government Securities. Also referred to as the bid-to-cover ratio.” Let’s take a quick look at the data and then what it might mean for investors.

So what does all that mean? Well quite a bit actually!

The main point is that the coverage ratio dipped below two twice in June. This directly affects the ability of the Federal government to finance its deficits. If buyers dry up-for whatever reason-we imagine either the auction would fail, OR, the Reserve Bank would have to step in, Fed style, with some direct purchases of government securities.

This shows that quantitative easing-the kind of thing that weakens a currency by increasing the money supply-is not so far-fetched in Australia as you might think. Granted, Aussie public deficits and debt are modest compared to countries like the U.S. and U.K. But while it’s a huge exporter of natural resources, Australia is a huge importer of capital. And that puts government finances in a vulnerable position if the bond auctions are not supported by domestic and foreign buyers.

The more debt the Federal government puts on auction, the more pressure it puts on the Big Four banks to snap it up. But that may not happen according to plan. “Of particular concern,” reports Katja Buhrer in the AFR, “is the suggestion that banks-keen buyers of commonwealth bonds to exploit an arbitrage opportunity in bond markets-are artificially propping up demand.”

It’s been argued that there will be plenty of domestic buyers for government debt. But according to Buhrer, “Demand from local fund managers for commonwealth debt has been lacklustre, with fund managers preferring to snap up insured state-government debt which offers higher yields. [Ironically the state government debt was guaranteed by the Federal government, which now appears to be driving up costs of Federal borrowing].

There doesn’t appear to be much rhyme or reason to the maturities offered by the AOFM. And to the extent that the AOFM has to compete with the States or corporations on shorter-maturity bonds and notes, it means interest rates will go higher (it will cost more to borrow). On the other hand, the AOFM could offer longer-dated bonds and notes. But as you can see from the table, the longer you take to pay back principal, the higher interest rate creditors typically demand.

But aside from the upward pressure on interest rates that government borrowing seems bound to produce, the big issue is who Australia’s creditors are going to be. Will it be Aussie banks? Or, in a country that’s traditionally an importer of capital, will it be off-shore creditors? And will those creditors be friendly?

With a US$1 trillion annual deficit (the first time ever) we know the U.S. government is not likely to be a creditor. It’s a chronic debtor. On the other hand, there’s this little country up the north that now has over US$2 trillion in foreign exchange reserves it wants to invest.

True, this tiny country has had trouble investing that money in Australian resource companies via equity recently. And that’s caused a few problems here and there. But when you generate a capital surplus by producing things and selling them instead of consuming things with borrowed money, you have to put that surplus capital to work somewhere, don’t you?

If Australia is looking for a creditor to guarantee its bond auctions don’t fail, it ought to look no further than China. But the relationship is a bit complicated at the moment. And we wonder what the Australian government and the Reserve Bank would do if faced with the choice of borrowing from China or printing more money to support demand at Australia’s growing number of bond auctions.

Hello rock. Meet hard place.

Dan Denning
for Markets and Money

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.

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5 Comments on "How to Boost Your Retirement Income"

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Cyber Cynic

Great…. Super from 9% to 12%. That just means more of our income will be controlled for years. All because the government thinks I’m too stupid to manage my money. Maybe I won’t spend or invest my money in the way they see fit…. How about letting us make decisions for ourselves? Oh, that’s right we don’t live in that world do we…. Government knows best. Ha!


I don’t think the government is that concerned with bonds auctions. Just jack up the “contribution” rate to 12% then make bonds a compulsory holding of super funds. Problem solved – unpleasantly but solved all the same.

You say ‘One way to NOT build wealth is to borrow’ I disagree with you, provided you borrow at say 10-15 years fix rates and buy residential property you WILL build wealth. And that’s even without any of the tax incentives the government is throwing around these days. All that stimulus money will eventually come back to bite us in the arse by the way of inflation. The more you can borrow at fix rate to invest in solid assets benefiting from strong inflation like property, land and defensive blue chip stocks like WOW (’cause everybody has to eat) the… Read more »
A question I have in the lively debate of required asset classes is to invest in – what will happen to the equity premium we require to punt the stockmarket as opposed to fixed income [cash], housing etc moving forward as opposed to historic = that is the return required above inflation on average af te the GFC has changes the investment rules we have for so long assumed housing is supposed to return 2-3% on average above inflation – on an after tax return is this enough to generate some future wealth = as I think long term analysis… Read more »

“the current system effectively prevents you from using this money the way you see fit. It denies you control of your own property, presumably because you are too stupid to look out for your own interests”

Unfortunately this is true for 95% of the population, and with no chance of tax-payer funded pensions in the future there is no real viable alternative.

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