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Dr Shane Oliver, Head of Investment Strategy and Chief Economist at AMP Capital, talks about how to invest for retirement in the light of key demographic changes.
How should investors adjust their strategies in the lead-up to retirement as we work longer, retire later and potentially receive less age pension?
The traditional approach was that you’d shift your investments into less risky defensive assets as you got older.
This is still valid to a degree, but you need to think more about your impending retirement – both when you’ll retire and how long you’re likely to live beyond that.
With the pension age increasing, you might end up retiring later. And then when you do retire, the odds are you will live for longer. With life expectancy now over 80, even someone who retires at 70 could potentially have 15 years or more to go. So you need to make your retirement savings last longer.
If you’re 55 and you’ve potentially got another 15 years to go until you retire, you might consider starting to think about how to make a transition towards retirement and delaying the ‘derisking’ of your portfolio because you’re less vulnerable to market falls in the short term.
What’s the best way to guard against the risk of retiring in a bad year for investment markets?
This is called ‘sequencing risk’ and it’s one of the biggest concerns for investors approaching retirement. A big share market fall just before retirement or in the first years of retirement can adversely affect you right through retirement. If share prices fall towards the end of your retirement, it’s not as big a problem.
History suggests that the sharemarket experiences a significant fall about once every 10 years. But if you focus too much on avoiding a crash, you end up losing out on the higher returns that shares offer.
There’s a balance between having some sort of protection and trying to maintain exposure to growth assets. It’s a difficult trade-off and there isn’t an easy answer. One solution is a protected portfolio with some sort of guarantee. But then that could also mean lower returns.
The best approach is to talk with your financial planner about how much risk you’re prepared to take on. One way to look at it is how much potential return and therefore protection against a longer retirement do you want to give up in return for protecting your investments in the short term?
There’s no such thing as a free lunch. You can’t have access to shares at the same time as having no risk. Shares deliver higher returns over time but they come with significant risks. On the other hand, more defensive assets like cash and government bonds give you more security but don’t have anywhere near the same return potential.
So if you’re 55 and you’ve got a portfolio that you probably need to rely on for the next 25 to 30 years, you’ve got to try and balance out those two competing alternatives.
And how should investors adjust their strategy once they’ve retired?
An approach that makes sense is to divide your savings into two broad investment streams – income-based assets like cash, term deposits and yield-bearing investments to fund day-day-day living expenses and growth assets that focus more on longer term savings.
What about younger investors who have more time to save for retirement but are more likely to be affected by changes to the age pension?
The message flowing from policymakers is that we need to be less dependent on the age pension going forward. It’s going to become harder to get the pension, you’ll have to wait longer and means testing will be a lot tougher.
So you need to do everything possible to make sure your savings can last throughout a retirement that is likely to be longer than that of your parents. You need to make the most of your years in the workforce to build up a savings nest egg that will cover your retirement period without having to rely on the pension.
There’s often a tendency for investors to get hung up on what shares they should buy or which country to invest in or what fund manager to use. But the really important question to ask yourself is what mix of growth and defensive assets is right for you.
The returns we get from defensive assets are likely to be quite low in the years ahead because yields have fallen dramatically with very low interest rates.
So you should think about whether your superannuation fund is appropriate for your longer term saving needs. If you haven’t actively chosen where your super is invested, your savings may be in what’s called a ‘default’ fund. Traditionally many default funds have been balanced and one could argue that they don’t take on enough risk for young workers. Some of the newer lifecycle default funds introduced as part of the My Super reforms have more of a growth bias for younger members and that’s probably appropriate.
Growth assets are particularly important when you’re starting out in the workforce. You don’t want to spend your whole career with your fund in a low-risk option that will leave you with inadequate retirement savings.
What you need to know
This document was prepared by AMP Capital Investors Limited (ABN 59 001 777 591, AFSL No 232497). This document, unless otherwise specified, is current at 22 July 2014 and will not be updated or otherwise revised to reflect information that subsequently becomes available, or circumstances existing or changes occurring after that date. While every care has been taken in the preparation of this document, AMP Capital Investors Limited makes no representation or warranty as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This document has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this document, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This document is solely for the use of the party to whom it is provided.
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