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The Conversation

  • Written by The Conversation
imageLow interest rates mean people approaching retirement will have to reassess their approach to risk. AAP/Dean Lewins

With interest rates at or near-record lows and the recent release of the 2015 Australian government Intergenerational Report, people nearing retirement may well be evaluating their retirement investment decisions.

Retirees who invest in increasingly conservative assets, such as reallocating their capital from equities to bonds and/or cash, are under threat. If current low bond yields and cash rates persist, which looks likely, the lifecycle method of investing, with all its benefits, will fall short in meeting retirees’ income needs.

Lifecycle investing is the conventional idea of allocating capital into risky assets (equities) during your working life and then de-risking your super savings into more conservative assets (bonds and/or term deposits) as you approach retirement.

A glidepath is the relationship between a fund’s asset allocation and an individual’s age. While equity investment do not typically fall to zero at retirement for lifecycle strategies, many advisors justify the concept of a declining equity glidepath on the basis that retiree’s horizon decreases with increasing age.

Put simply, the young investor is assumed to be able to accept more risk than the older investor. Hence the young investor should invest a large proportion of their savings in equities at the onset and gradually reduce the allocation to equities over time.

Although recent studies suggest otherwise, financial planners are resolute in reducing their clients’ asset allocation in equities when their clients approach retirement. Why? Because it seems right! Conventional thinking suggests that retirees with a moderate nest egg will look to protect their savings in retirement and deploy their lifetime savings in low risk investments.

A big challenge to the lifecycle strategy in an era of low interest rates is accumulating enough lifetime savings to fund your longevity risk. This is the risk of individuals living for an unusually long time and thereby outliving their retirement incomes.

In Australia, many funds use the Strategic Asset Allocation (SAA) framework as a default investment strategy. This strategy is representative of the optimal combination of different asset classes. These assets are periodically rebalanced to the target allocations as investment returns skew the original asset allocation proportions.

With the masses of Australians paying their Superannuation Guarantee (SG) into their fund’s default strategies, the Australian government introduced a cost-effective product called MySuper.

There are currently 116 MySuper products, 88 of which have a single investment strategy with the remaining having a lifecycle investment strategy. The static strategy has up to 49% of assets invested in equities while the lifecycle strategy holds approximately 31% of wealth in growth assets (equities) at retirement age 65 and the remainder in conservative assets.

Research has shown that the SAA outperforms portfolios with decreasing asset allocations in equities. More importantly, recent studies find evidence to support an increasing (that’s correct, increasing) asset allocation to equity investments in retirement which challenges the conventional thinking in the financial planning profession.

The increasing equity glidepath has the potential to reduce both the probability of failure and the magnitude of failure for investment portfolios. The idea of an increasing equity glidepath in retirement may present some concerns for retirees from a risk tolerance perspective, and therefore require a very meticulous approach.

Life expectancy among Australians is among the highest in the world today. Retirees have elongated life expectancies of up to 86 and 90 for males and females, respectively. There is a 15% chance that one person of a retired couple will live past the age of 95.

Some 20% of white collar male and females are now expected to live to age 94 and 96, respectively. And 5% of the male white collar cohort will live to age 99, with the females living beyond 100. These statistics suggest that if you’re planning to retire at 65, you potentially face a very long retirement period which you will need to fund. The current world of low interest rates means retirees investing in safe assets risk facing financial ruin over long retirement horizons.

These low interest rates in today’s financial markets may be the “nudge” financial advisors need to address the issues of longevity risk. One proven method is to consider these new equity-focused investment strategies that exhibit a higher probability of investment success. Although the past is not necessarily indicative of the future, it is illustrative for risk purposes.

Strategies that follow the concept of de-risking with increasing age under-performs contrarian strategies given 141 years of historical data. When we lower our expectations and live in the present, with low yields and market uncertainties, the outcomes do not change. Equity-centric strategies perceived to be riskier provides more certainty with retirement outcomes.

The eminent economist John Maynard Keynes famously said, “When the facts change, I change my mind. What do you do, sir?” From a retiree perspective, when bond/cash yields change, let our investment and retirement advice change along with it.

Osei K. Wiafe does not work for, consult to, own shares in or receive funding from any company or organisation that would benefit from this article, and has no relevant affiliations.

Authors: The Conversation

Read more http://theconversation.com/low-interest-rates-set-to-stay-so-whats-the-best-investment-course-for-retirees-39509

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