We all know that it is essential to save for our retirement and superannuation has become one of the main products to do just that.
So for years we contribute to super, yes there are many smart ways to speed up the process of growing your super by using smart contributions, and those will be different for each person, at a different period of time.
This is how your retirement outcome and be improved.
In my pretty comprehensive by now library, you can learn about:
1. salary sacrifice
2. downsizer contribution
3. concessional contributions – 4 reasons to make personal tax-deductible super contributions
4. Unused super contributions – so-called Catch-up carry-forward contributions
5. End of financial year smart contributions
And many more articles explaining different topic relating to saving and investing in super.
There are various factors that will affect the outcome of your super at the retirement stage:
1. amount of money contributed – the more invested the better the outcome
2. types of contributions made (how much tax has been deducted over the years) – the less tax withdrawn, the better your outcome
3. time spent within the investment environment – the magic of compound interest.
4. any withdrawals made (eg during Covid) – please pay those withdrawals back, you still have time
5. fees paid – that is very important, but not as much as the government or those super funds adds on TV make you think. This is easy marketing.
By the way, who do you think pays for all those TV ads run by big super funds? You do!
6. But one of the most important factors is investment returns.
So today, we will discuss the most important and not really explained aspect of investment returns that will impact your retirement outcome like nothing else will.
Earl Nightingale said – “As in all successful ventures, the foundation of a good retirement is planning.”
And your good planning should include good investment planning as well.
Investing is a bit like climbing the mountains:
- we have periods of good returns, and we are climbing our mountain
- then there are periods when market is flat, well at least it is a comfortable walking, no big stress
- but then we experience a period that feels like falling
- as long as we don’t panic and we don’t do silly things like selling off your investments after a bit of market fall, off we go up again
- until one day we are right on the top of that mountain, and this is the time we are ready to retire.
But, that climbing journey can be a different experience and a different outcome for every person. Why? As I mentioned before, one of the major factors that impacts the outcome of your retirement portfolio are returns, specifically the order in which the returns have been receive, so called “investment sequencing risk”.
And this is where I question the whole advertising of the “fantastic average returns” you see on superannuation adds on TV.
To prove my point, let’s compare Margaret and Jane
Both have a starting super balance of $200,000 at the age of 55
Both contribute to super $25,000 every year
Both run that super till the age of 65
Both received an average return of 7.2%p.a
For the purpose of this exercise, we disregard the superannuation tax.
As you can see both women had an average return of 7.2% and yet Jane ended up with over $92,000 less in here final superannuation balance.
So this average return is not a solid indicator of what you can expect to have after many years of saving.
Bottom line is that “sequencing risk” is the risk of ending up with less money that you originally calculated you might have at your retirement stage.
What option do you have then?
- More investment risk required to make up the losses
- Changed retirement plans – retire later
- Less money invested when commencing retirement – lower income
- Bigger chance of running out of money
Or control investment risk better.
At the end of the day, the last thing you want is to end up with this picture, we don’t want to fall off the cliff.
Instead, it is much more pleasurable and safer to be slowly walking off the mountain:
what we are trying to do is introduce in a smooth, predictable, secure, solid and predetermined levels of income, as well as capital returns. Managing an investment risk is a sure way to prolong life of your savings, your income and your capital.
So how can we deal with investment risk?
- You have to make sure that your portfolio is really well diversified – diversification between assets classes really helps reduce the volatility of returns and especially impact of market falls.
- Use conservative assumptions when forecasting – if you know that in order to get the outcome you need a return of 8%, prepare yourself for a more conservative returns of say 7% or even 6% and you will not be disappointed, you can prepare yourself better, you can always add more money. If the market surprises you with a better outcome, that is just a huge plus, your cream on a cake.
- Invest into assets that not only grow in value, but also provide a good level of income, reliable income I mean, such as property, shares, especially Aussie shares. I don’t mean to disregard other asset classes, remember rule No 1 – diversification?, but in investing growth is the part that is so volatile and unpredictable. Income is usually part of the investment return you can rely on, is more stable and more predictable.
- Invest portion of money into conservative assets to reduce volatility and limit impact of negative returns.
- Rebalance your portfolio when the market presents correct opportunities
- Introduce a market fall “floor” to your investment strategy, so you know in advance the worse case scenario and your savings will never drop below what you are willing to accept as investment risk.
- Keep your next year income in cash
- Speak to a financial planner that has access to many products that really can assist with controlling investment sequencing risk, can set up a secure, reliable and predictable income stream for you, and can minimise impact of negative market returns on your portfolio by introducing limits, negative returns “floor”, returns guarantees that no matter how badly the market drops, your portfolio will not be part of it.
So at the end of the day, this is what we are trying to achieve:
Introducing Anne, the same investment with the same average annual return of 7.2%pa and yet a vastly different outcome:
Anne’s outcome is $22,312 better than Margaret’s and a whopping $114,329 better than Jane’s.
Obviously the higher that return the better, but the main idea is to control the sequencing risk, so you don’t end up with huge losses just before your retirement, as it is very difficult to recover such losses, once you are in the retirement phase.
The idea of a good investment planning is to introduce different investment instruments that as an overall return, provide this smooth and reliable rate of return, income and capital, without the feeling of falling off the cliff, but rather an enjoyable and comfortable walking off the mountain with hopefully funds left behind for the next generation if you wish.
Therefore, unlike what super funds would like you to believe, transferring ALL your superannuation savings from the accumulations account to an allocation pension, or account-based pension is most certainly not the way to go, as you continue exposing your total retirement assets to ongoing sequencing risk of market volatility. That is the worse possible choice you could make, as it really creates a highly probable risk of running out of money.
So please take care of your investment “sequencing risk” to reduce the impact of market volatility on your investment portfolio and retire with a degree of safety and certainty.
“Retirement is a Journey NOT a Destination, so be well prepared for the ride”
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