Simple steps to protect super for when it is needed most

9 December 2020:

Working longer, diversified equity, fixed-term deposits and annuities can avoid portfolios being smashed.

The extreme market volatility caused by COVID-19 and the global financial crisis highlight the need to start planning long before stopping work to secure a sustainable retirement income.

That's the experience of many retirees such as Gill and Elizabeth Fryatt, both 71, whose retirement strategy was disrupted by the GFC in the lead-up to retirement and who have since had to absorb the financial chaos caused by the pandemic.

“Diversify across a range of assets,” says Gill, a retired farmer and investor who lives in Ballarat, about 115 kilometres north-west of Melbourne. “Don’t put all your eggs in the same basket.”

After the GFC he restructured his portfolio to improve diversification and increase liquidity, as well as keeping 10 per cent in cash and short-term deposits.

Major super providers, including AMP and AustralianSuper, have developed products and strategies to help investors manage "sequencing risks" in the lead up to retirement and when drawing a pension.

Sequencing risk refers to when an adverse series of returns can have a significant impact on a retirement portfolio, says Josh Funder, founder and chief executive of Household Capital, which specialises in allowing property owners to borrow against the equity in their home.

For example, two savers make net contributions of $10,000 per year for 20 years and earn 7 per cent per annum from years two to 19.

One saver had a 10 per cent loss in the first year and a 10 per cent gain in year 20 and the second saver had the opposite returns – a 10 per cent gain in year one and a 10 per cent loss in year 20.

There will be more ‘market tantrums’ next year amid further fallout from the pandemic and political uncertainty.

The second saver's loss happened when the balance was the largest and the saver closest to retirement. Their account balance at the end was $81,000 lower than the $483,636 balance of the other saver, who experienced the significant negative return early on, with a much lower impact.

Kevin O'Sullivan, chief executive of UniSuper, who provided the example, says: "It is a tricky issue and depends on your personal circumstances, risk tolerance, fund levels and other sources of income."

O'Sullivan, whose fund has about $85 billion under management, says: "There is no optimal risk level. Too little may result in insufficient income, too much can erode savings and sustainability of retirement income."

Financial losses from COVID-19, or any big market events including the GFC, can force savers to postpone retirement and continue to work to boost savings or retire on less income.

The potential for damage was highlighted in the four weeks from late March when the ASX/S&P 200 Index fell more than 44 per cent to about 4550 points as investors ran for cover at the outset of COVID-19′s forced lockdowns.

Those who bailed out of growth stocks for the security of fixed income or cash “effectively crystallised their losses” and missed out on the sharp rebound, says O’Sullivan.

He says the period of greatest risk for achieving a sustainable income is typically in the last 10 years of accumulation (or saving) and the first decade of retirement.

According to Fidelity International, which manages more than $600 billion, there will be more “market tantrums” next year amid further fallout from the pandemic and political uncertainty.

What to do

The recent government retirement income review highlights the risk to people close to retirement – or those already retired – that may be forced to make stressful decisions that may have a permanent impact on their retirement income. This includes nearly 3.9 million retirees and hundreds of thousands expected to retire over the coming years.

A high-risk strategy to boost returns increases vulnerability to market swings while a low-risk savings account strategy will preserve capital but is unlikely to generate a living income, says Tracey Sofra, a partner at Sofcorp Wealth, a financial adviser.

Strategies to mitigate risk include:

• Investing for longer. Shane Hancock, the head of advice at AustralianSuper, which has more than $188 billion under management, says a transition to retirement strategy lets those who have reached preservation age access some of their super as income, while they still work. “Since people are still working, employer payments mean their super balance continues to grow. And at the same time, they receive money transferred directly to their bank account from their (transition to retirement) income account,” Hancock says. “Another way to manage sequencing risk is to transfer super savings into an account-based pension and draw regular income payments while the balance stays invested,” he says. “This gives people the potential for continued long-term investment returns throughout their retirement. They can choose how much income they want to receive (subject to the regulatory prescribed minimum) and how often.”

• Buying annuities and/or deferred annuities. AMP has a product that provides a partial or full guarantee of capital for five and 10 years. At worst, an investor will get their initial investment back (before fees), irrespective of market performance. Fees for the five-year guaranteed product are 1.25 per cent per annum, or 1.95 per cent with optional growth lock-in. For 10 years they are 1.45 per cent and 1.85 per cent respectively.

• Taking a more conservative investment approach as retirement approaches. A man retiring at 60 can expect to live another 18 years and a woman 24. “The ultimate focus has to be how much you want to have on retirement and what portfolio provides that in terms of capital preservation and returns,” says Sofra. “The basic principals do not change just because you have retired,” she says.

• Working longer. According to Rafal Chomik, a senior research fellow at CEPAR, which researches ageing, Australians' life expectancy and length of life in good health have increased by about four years since 1990. “Jobs have changed too,” he says. “We’ve seen a long-term decline in manual labour, for example. Jobs requiring non-routine and strategic thinking and people skills, in which older people have an advantage, have increased.”

• Keeping sufficient assets in a liquid fund and diversifying savings. Savings rates plunged as the Reserve Bank cut the cash rate to 10 basis points and the Australian bond 10-year yield slipped to 0.89 per cent. An alternative could be low-risk, investment-grade bonds, says Elizabeth Moran, a director of FINA, which monitors fixed income. These might include Dexus Group senior unsecured with a 1.53 per cent yield to maturity (YTM) in May 2027; Downer Group senior unsecured with a 2.55 per cent YTM in April 2026; and Lend Lease senior unsecured green bond with a 2.3 per cent YTM in November 2027.

• Keeping sufficient assets in a liquid fund. This strategy will avoid the need to sell investments after a significant market fall, says UniSuper’s O’Sullivan. But it does not provide protection from risk on the balance of the portfolio.