With the global markets getting the wobbles and the local share market developing a case of the ‘iron ore blues’ (resulting in a 5% fall in our market), some readers are wondering how much exposure they should have to shares in their superannuation fund — increase, decrease or sit tight.
The queries followed on from my 11 September 2014 Daily Reckoning article, Let’s Continue the Super Debate.
In the article, I put forward a contrary opinion to Alan Kohler’s theory that superannuation funds should abandon ‘the stupidity known as asset allocation theory’and be entirely invested in the share market (based on superior past performance). I argued past performance is no guarantee of future returns. The above average equity returns of the past 30 years has created an aura of awe that has blinded us to the cyclical nature of markets.
Life hasn’t always been ‘all sunshine and roses’. We’ve had extended periods of secular bear markets throughout the history of the Australian share market. Unless cycles have been made redundant, it’s a fair bet these dark periods will come again.
Also, investors have different risk profiles and investment horizons, so a ‘one-size-fits-all’ approach to asset allocation is not appropriate.
It’s these differing time horizons that generates queries like:
‘I’m approaching retirement in the next couple of years, so should I sell down or sell out of my shares?’
‘In my early 30s and worried about getting access to my super. Does it matter whether it is all in shares or not as I am not likely to get my hands on it?’
Another email went deeper into the appropriate investment strategy for the lifecycle of superannuation. The writer, John, is a senior executive with an international investment institution. He makes some valid points:
‘I refer to Vern Gowdie’s article and agree with him now is not the time to be "all in" equities. I also agree with Alan Kohler’s view that it is best to be in equities for the long term. A few years ago (pre 2009), I had some calculations of returns for the Japanese equities market done allowing for dividends and on regular monthly investments.
‘I recall that while the Japanese market had done almost nothing over the previous 15 years or so with dividends and regular investments the results beat inflation and investment in cash or bonds. So if one of the future scenarios is a flat market, low inflation and low interest rates investment in dividend paying equities may still be the right strategy for super fund members.
‘The issue I wish to raise is that of scaling down equity investment as one approaches retirement. This is almost universally touted as the correct or best approach by commentators. I beg to differ. Unless the intended strategy post retirement is to invest all or most of the accumulated super benefit in a fixed annuity then it makes little sense to advocate high equity exposure pre-retirement and low equity exposure at and post retirement.
‘Most of us will live many years post retirement. My guess is that most retiring today will live beyond age 90. I know that is not what current life statistics say but they do not take account of future medical improvements over the next 25-30 years. If one’s plan is to draw down a variable pension at or close to the minimum rate the pension fund will diminish slowly. One’s risk appetite does not change. If it was the correct strategy to invest a high proportion in equities while accumulating a super fund my view is it remains appropriate to hold a high proportion in equities approaching and post retirement. Perhaps risk exposure should be reduced when life expectancy reduces to 10 years or less – and when valuation ratios tell us so clearly the market is overvalued as they do now.
If we go back to the basics, the superannuation lifecycle is divided into two phases — accumulation (age 20 to 65) and pension (age 65 to 90).
The phases are static; the ages are variable.
The accumulation phase relates to the merits of John’s calculation on regular savings into the Japanese share market.
The chart below is the performance of the Nikkei 225 since January 1985. You are looking at ‘heartbreak hill’.
Five years of ecstasy followed by 25 years of grinding torment.
Even the most one-eyed share devotee can see that a buy and hold strategy on Japanese shares over the past 30 years would have been excruciatingly painful.
However, as John rightly points out, a monthly savings and dividend reinvestment plan (the accumulation phase) into ‘heartbreak hill’ could produce a positive outcome.
Dollar cost averaging (investing small amounts on a regular basis) is one of the best risk minimisation strategies in the wealth creation business.
However, life is not one dimensional. The longer the period of dollar cost averaging, the greater the potential for a successful outcome. Therefore, time is an important consideration.
Secondly, the more successful your dollar cost averaging strategy is the greater the account balance you need to protect in thirty years’ time. Your few hundred dollars of savings in 1985 is now worth several hundred thousand dollars. Suddenly the market volatility that worked so well for you during the accumulation phase is no longer your friend.
Take a close look at the Nikkei 25 chart and you’ll see in 2008/09 that the market fell over 50%. Think about it, nearly 25 years of savings were cut in half in a few months. Ouch…especially if retirement is imminent.
Fortunately, for the Japanese saver who had the nerve to stay the distance, the Nikkei has nearly recovered to its 2007 level.
But our long term Japanese saver is now five years older (and a little wiser and perhaps a little gun-shy). What do they do now? They suspect the market ‘recovery’ has been fabricated with Abenomics. Do they stay the course even though the day they collect their gold watch is fast approaching or do they cut and run? What would you do?
I’d cut and run.
This dilemma goes to the heart of the appropriate investment strategy for superannuation. It completely depends on your time frame, capital accumulation, your age and retirement income needs.
As a rule of thumb, I agree the share market is the appropriate investment for regular savings over the long term — 20+ years.
However, the closer you are to retirement the more you need to be cognisant of market conditions and the impact a substantial fall could have on your retirement aspirations.
Since 2000, there have been two substantial (50%+) market corrections. Each time the market has recovered…thanks to the Fed’s increasingly accommodative policies.
But what happens next time? What if the stock market fails to respond to the Fed’s medicine?
The Fed’s actions to rescue markets and the economy have been labelled in many quarters as ‘unprecedented’. We have not been here before. Therefore, using past performance (delivered during the boom period that created the massive imbalances we have today) is, in my opinion, the worst possible predictor of what lies ahead.
Which brings us to the appropriate strategy for the superannuant approaching or in retirement.
According to John:
‘If one’s plan is to draw down a variable pension at or close to the minimum rate the pension fund will diminish slowly. One’s risk appetite does not change. If it was the correct strategy to invest a high proportion in equities while accumulating a super fund, my view is it remains appropriate to hold a high proportion in equities approaching and post retirement. Perhaps risk exposure should be reduced when life expectancy reduces to 10 years or less — and when valuation ratios tell us so clearly the market is overvalued as they do now.
I disagree with John on a few points. First, ‘one’s risk appetite does not change’.
My coal face experience in financial planning taught me that a person’s risk levels do change depending on prevailing social mood and where they are in their life.
In Australia, our last recession was over 20 years ago. The absence of severe economic times has conditioned our social mood to be more positive, and risk profiles reflect this. However, if the world falls into a Great Depression type scenario, I’ll bet you London to a brick that risk profiles migrate to the more conservative end of the spectrum. And even more so for older people.
Second, ‘if it was the correct strategy to invest a high proportion in equities while accumulating a super fund, my view is it remains appropriate to hold a high proportion in equities approaching and post retirement.’
The reality is that it depends.
Below is a chart that was included in the September 11 Markets and Money article.
Let’s say you started a very long term (50-year) savings plan (accumulation) in 1877. By 1927, your diligence has rewarded you. You’ve managed to save enough for a comfortable retirement. You decide to stick with what worked for you during the accumulation phase — shares.
Retirement goes well for a couple of years. Then 1929 hits. Your 50 years of accumulated wealth turns to dust in a couple of years.
Nothing is black and white in these dynamic and bipolar markets.
If we frame our argument around the past 30 years (which have been extraordinarily good for markets), we discount what markets are capable of when the mood turns decidedly nasty. So be discerning and question the premise of projections and predictions. Your future depends on it.
Tomorrow, I’ll show you why you must be extremely careful about the level of share exposure you have when you start the pension phase of your superannuation lifecycle.
For Markets and Money