Investing in Retirement

Stability back in fashion

Lesley Parker

April 20, 2011

Balancing act...investors are advised that a diverse portfolio is important to achieve an adequate income in retirement.

Three years after the peak of the global financial crisis, retirees and pre-retirees remain wary, saying they would rather have peace of mind than chase high returns, according to new research.

In a survey late last year, researcher Investment Trends asked 1000 retirees and pre-retirees what they thought was most important in a retirement investment product and they overwhelmingly valued stability over high returns.

The five features the respondents ranked most highly were tax effectiveness (which was rated as essential, very important or important by 91 per cent of those surveyed); easy access to their money (87 per cent); a product that was easy to understand (86 per cent); stable returns (86 per cent) and protection against market falls (77 per cent).

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''These results turn established wisdom on its head, with stable returns proving much more important than higher returns or lower costs,'' says the chief operating officer of Investment Trends, Tim Cobb. ''That may reflect investors' experiences during the GFC, with many experiencing large and unpredictable fluctuations in their retirement savings.''

ANNUITIES AND GUARANTEES

Cobb says the results indicate it might be ''time for investors and advisers to take another look at annuities and some of the innovative new retirement income products which offer protection against market falls''.

Annuity-style products, with their contracted rates of return, have been a hard sell for many years and especially while the sharemarket offered double-digit returns.

However, anyone who watches television will have seen how Challenger's ad campaign taps into the anxiety retirees are feeling by promoting ''safe, reliable retirement income'' from its annuity products.

With these products, you make an initial investment in return for agreed income payments over a contracted period. The rate of return is fixed at the outset and doesn't fall if markets go down - but it doesn't rise if markets go up, either.

Then there are ''capital-protected'' products. AXA's North product, for instance, offers an optional ''protected retirement guarantee'' feature that locks in guaranteed income.

Advisers say clients, particularly retirees, are more wary because of the GFC but their advice to them is not to give up on risk - market risk - only to take on other forms of risk, such as the danger that inflation will erode the value of their retirement savings.

An HLB Mann Judd financial adviser, Chris Hogan, says that while most of his older clients are more risk-averse, ''they still recognise that growth assets are an essential component of their investment portfolios''.

NO FREE LUNCH

A financial adviser and director of Multiforte Financial Services, Kate McCallum, who also finds retirees in particular are more risk-aware, says ''it comes down to the practical challenge of how to protect capital while achieving the return they want''.

She gets the occasional inquiry from a client about annuity or capital-protected products ''but we're not fans of protected products as they're very expensive and we believe a well-constructed portfolio that's managed - not set-and-forget - can be a better option''.''I suppose the key message here is: there's no free lunch,'' McCallum says.

''There's a cost of having the capital protection and the certainty and this needs to be evaluated for each client [with regard to] their comfort level with volatility and their return requirements.''

Hogan says he doesn't see much interest in annuities and capital-protected products, either. ''Our view is that we don't need to get too tricky with innovative products,'' he says. ''Protection is available simply and cheaply through holding term deposits, uncomplicated fixed-interest funds and cash'', as part of a diversified portfolio.

He, too, notes that capital protection typically comes at a cost. ''For an annuity, the cost is lack of liquidity,'' he says, with your capital sum locked up for a set period.

People also need to compare the return being offered on an annuity with term deposits, which currently have quite high interest rates.

''For other structured products with capital protection built in, the underlying fees can be very high,'' he says. ''We generally don't think the cost is worth it.''

(In a recent relaunch of the North platform, AXA - well aware of criticisms concerning cost - cut its standard administration fees, halving the rate for smaller account sizes from about 0.9 per cent to 0.4 per cent.)

McCallum notes that with many capital-protected products there's a set period for the protection to work. ''If you have to break the set term, there are usually hefty penalties associated with that.''

DIVERSIFICATION IS BEST

The head of retail for Australian Unity Investments, Cameron Dickman, says those who keep their money in cash aren't necessarily working towards their ultimate goal of having a retirement income that lasts as long as they do.

While keeping a significant proportion of retirement savings in cash options such as term deposits minimises market risk, ''it exposes investors to a number of other risks, including inflation risk, income risk and opportunity risk'', he says.

Inflation risk is the risk that capital locked up in non-growth assets, such as term deposits, will have less value at the end of, say, a two-, three- or five-year term.

Opportunity risk is the risk that you'll miss out on better returns and capital growth from opportunities that might become available while your money is locked up.

Perhaps the biggest risk at the moment is income risk, Dickman says.

A stable, regular income will become a priority for the baby boomers now starting to enter retirement but they won't get that from a term deposit for which interest is often paid at the end of the term, he says.

''Retirees, in particular, need to … find a balance between their desire for low-risk investments and their need for returns that will generate ongoing income in their retirement,'' Dickman says. ''It comes back to the value of taking a balanced approach through a diversified portfolio and understanding that different investments offer different benefits, returns and risks.''

Key points

• Retirees are more interested in stable returns than high returns or low costs.
• Capital-protected and annuity products tap into this concern.
• But advisers say the cost of such products has to be weighed against the promised peace of mind.
• They warn that being in cash to avoid market risk means you take on other risks, such as inflation.
• Diversification is the best protection, they say.

 http://www.smh.com.au/money/investing/stability-back-in-fashion-20110419-1dlzl.html#ixzz1MT4O7Zax

Dollar hits global gains

May 11, 2011

Downside of strong dollar...global shares produced an average annual return of minus 4 per cent in the past decade.

Blame the terrible returns on international shares during the past decade on the Australian dollar. There was a dramatic dip in the value of the Australian dollar in 2008 and into early 2009, when sentiment about world economic growth was at its gloomiest, but otherwise it's been on a steady rise during those 10 years.

Most people access international shares through managed funds that allow the currency effects to flow through to investors.

The dollar's rise has more than sliced away the gains on overseas sharemarkets, leaving investors in the red.

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During the 10 years to the end of March this year, international shares have produced an average annual return of minus 4 per cent.

With losses compounding during such a long time, the original sum invested 10 years ago would be worth about half today, after accounting for inflation.

But the same portfolio, hedged or protected from exchange-rate fluctuations, has produced an average annual return of about 3 per cent during the same period. The difference between hedged and unhedged is 7 percentage points each year.

Investors could be excused for thinking they had invested in a foreign exchange fund rather than an international share fund.

About half the typical portfolio will be invested in US-listed shares, as the US makes up about half of capitalisation of developed-word sharemarkets. That means the US dollar is the currency exchange rate with the biggest impact on the returns of the unhedged portfolio of international shares. A decade ago, one Australian dollar was buying about US50¢. Last week it was buying more than $US1.10.

After 10 years of losses, many investors will be wondering what they should do now. Assuming they still want the diversification benefits of global shares, should they switch to a fund that removes the currency effects on their returns? During the next few years you would think the Australian dollar will stay high because of the resources boom keeping commodities prices high and Australian interest rates relatively high. Given the Australian dollar is so highly valued now, if there was to be a change in the value of our dollar, it is much more likely to be down than up.

If that is right, there may be nothing to gain from being in an international shares fund that removes the currency risk. There may be more to gain from leaving the international shares exposure unhedged to benefit from any dips in the value of the Australian dollar.

Another approach may be to include more exposure to emerging markets. The typical global shares fund has only a small exposure to emerging markets. But shares listed in China and India and other emerging countries are likely to keep doing well. Perhaps the best option is to consider managers who actively manage the currency risk, have a decent exposure to emerging markets and are not afraid to invest differently to their peers. This approach is more likely to be found among, but not limited to, boutique fund managers who specialise in managing global shares funds.

http://www.smh.com.au/money/super-and-funds/dollar-hits-global-gains-20110510-1eg2y.html

Reap the fruits of your labour

Annette Sampson

May 11, 2011

Matter of choice...the fund you choose is a critical decision. Photo: Erin Jonasson

Don't ruin your retirement by leaving your money in a lagging super fund, writes Annette Sampson.

Inertia is costing super fund members tens of thousands of dollars in lost earnings and future retirement benefits.

While most employees have the right to choose where their money is invested, or at least choose an appropriate investment option within their fund, the vast majority don't exercise that right.

This is creating a lucky-dip universe where those fortunate enough to land in a good fund do well but others unknowingly remain in underperforming funds that can severely limit their lifestyle when they reach retirement.

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Money Tables

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Research for Money by SuperRatings shows that the median return for super funds generally quoted in news reports disguises the fact that some funds perform much better than the average - and some much worse.

Despite the Howard government's introduction of fund choice, about 80 per cent of super money remains invested with employers' default funds. Much of this money is in the default option of that fund - typically a balanced portfolio, which SuperRatings defines as being one that has 60 per cent to 76 per cent of its investments in so-called growth assets such as shares and property.

Over the 12 months to March 31, the median balanced fund returned a solid 5.1 per cent - largely thanks to the post-GFC recovery in global sharemarkets.

But if you were unlucky enough to be in the worst performer on SuperRatings's database, you would have lost 1.9 per cent over the year.

By contrast, the best performer returned 8.2 per cent - more than 10 percentage points better than the laggard and three percentage points better than the median.

MASSIVE DIFFERENCE

Of course, super isn't a short-term game and the fact that your fund may not have done well over a particular 12-month period generally isn't cause to run screaming in the opposite direction.

The managing director of SuperRatings, Jeff Bresnahan, says different funds do well at different points in the market cycle and he would generally recommend investors judge theirs over five years to seven years to gain a clearer picture of how well they do under a wider range of conditions.

But even over these longer periods the differences can be substantial.

Over the past five years, SuperRatings says the best-performing fund has returned 5.3 per cent a year while the worst has lost 0.9 per cent. Over the past 10 years, the best performer has returned 7.3 per cent a year, versus 2.8 per cent for the bottom-of-the-pack fund.

To put this into perspective, it says someone who invested $100,000 in both funds five years ago would now have $125,696 if they had been in the top performer; $95,582 in the worst. Five years is not a long time in terms of retirement savings but even over this sort of period, being in the wrong fund could have cost up to $30,000.

Over the past 10 years, SuperRatings says, $100,000 would have grown to $201,924 in the best fund and $131,549 in the worst. That's a difference of about $70,000 and while the top fund gave investors a healthy return, the bottom fund merely kept pace with inflation - lagging the performance of even the median cash fund.

Bresnahan says the past 10 years have been a good test of how funds cope with a full range of market conditions. ''We had the tech bubble and crash, then the rally in mainstream shares, the GFC and the mini rally following it,'' he says. ''If your fund has underperformed by a big margin over 10 years you'd have to consider whether it warrants sacking it.''

Bresnahan says that over five years, a five-percentage-point annual difference in returns generates a difference in outcomes of just under 30 per cent; over seven years, the difference is almost 40 per cent.

''That's where apathy costs [investors] big time, because we don't penalise managers who get it wrong.''

AVOID THE DUDS

The chief executive of the Australian Institute of Superannuation Trustees, Fiona Reynolds, says even a 1 per cent difference in returns can make a huge difference over your working life. She says inertia is costing some fund members dearly and the government is trying to address this problem through its proposed super reforms.

These include the introduction of a new low-cost default fund to be known as MySuper, having the regulator put out information so consumers can more easily compare funds and streamlining the administration of funds and making it easier for consumers to transfer between them.

However, Reynolds fears many consumers will remain unengaged with their super until their account balances grow to a size where they realise this is serious money.

The principal of Mercer, Russell Mason, says it is disappointing to compare financial homework with all the work people put into researching a new-car purchase. ''If only they put the same effort into selecting their super fund,'' he says. ''It would have a far greater effect on their situation.''

However, Mason warns that simply opting for the best-performing fund without knowing why it has done well can be dangerous - particularly if you use shorter-term performance results.

''One of the warning signs [that a fund might be a dud] is if it is performing well outside the range of other funds - either on the downside or the upside,'' he says.

''If 90 per cent of funds returned 7 [per cent] to 12 per cent last year and yours returned 3 per cent or 20 per cent, it should ring alarm bells. We have seen examples of extraordinary performance that comes about because of high risk and leaves investors very exposed if circumstances change.''

DON'T RELY ON LABELS

Mason warns that even within a definition such as ''balanced'' there can be legitimate reasons why one fund will do better than another. He says there is a big difference between having 60 per cent of your fund in growth assets and having 75 per cent. If two funds have the same official weighting, one might use more passive investments such as index funds while the other may have more illiquid assets such as infrastructure and private equity, or be more inclined to use more active fund managers.

''The vast majority of members have a poor understanding of what they're invested in,'' Mason says. ''Many hear 'balanced' and think it means a 50:50 mix of defensive and more risky investments.''

The head of investment consulting at Mercer, Graeme Mather, says a joint effort by the Association of Superannuation Funds of Australia and the Financial Services Council to produce a standard risk measure should help consumers better understand the risk-return trade-off. He says the move will require funds to estimate the number of negative years that investors can expect in every 20 years and they will then be rated on a scale of one to seven using that information.

While that doesn't address other risks in super funds, such as liquidity risk or the risk that the people running the fund will have problems, Mason says it should at least help consumers understand why a fund with a 10 per cent return but a low-risk rating may actually be a better prospect than one that has returned 12 per cent or 15 per cent by taking on much more risk.

AGE MATTERS

Reynolds says consumers should also be aware that if a fund is doing its job properly, it should tailor its investment strategy to its membership. This may mean a fund with a largely young membership will have different returns to one with mainly older members but both could be doing a good job.

''It's about what works for members rather than just how [the fund] compares to someone else,'' she says. ''There has been too much following the rest of the industry.''

Mather says one legacy of the GFC has been increased volatility in investment returns - though it has also created opportunities. SuperRatings'a figures show the effect of the GFC has by no means worked its way out of the system, with median fund returns over the past three and five years lagging, or barely in line with, inflation.

Over the past three years, the median balanced fund has returned just 1.3 per cent a year while the return over five years is a marginally better 2.5 per cent. ''People might look at that and say they'd have been better with their money in a bank account but most people wouldn't save for retirement without super,'' Reynolds says. ''The returns still don't look too good at the moment but for many people, retirement is still a long way off and over that time they'll be better off in the compulsory system.''

Set for double-digit returns

SuperRatings's figures show funds are on track for a double-digit return this financial year, which will come as good news to fund members still smarting from the losses incurred during the GFC.

The managing director of SuperRatings, Jeff Bresnahan says while the markets are still volatile and returns will swing up and down from month to month, the median balanced fund returned 9.53 per cent in the nine months to March 30 and could top 10 per cent if investment conditions remain positive.

Australian shares are the biggest driver of fund returns but Bresnahan says the good news is that funds haven't just been riding on the market's coat-tails.

He says the median Australian share option has outperformed the broader sharemarket over one-, three-, five- and 10-year periods, even after fees and taxes. He says balanced funds have benefited from this.

The two top-performing balanced funds - Catholic Super's balanced option and Local Super's growth option - both returned 8 per cent or more through the year to March 31 (though Local Super's conservative option did better with 8.5 per cent) and the top Australian share fund, NGS Super, produced a 10 per cent return. See tables page 6.

Bresnahan says capital stable funds have benefited from a flight to US, German and Australian bonds. International shares have also contributed to some funds' profits, though the rising Australian dollar has taken the edge off those returns for funds that don't hedge their currency exposure.

The SuperRatings tables show the top international share options have recorded stellar returns in the past year - as high as 11.1 per cent - though the GFC still has most funds in the red over the past three to five years.

However, the extent to which funds benefited from the recovery in overseas markets has depended on their currency hedging. SuperRatings says the MSCI World Index's return over the past 12 months was 12.36 per cent, after hedging against a rising Australian dollar. But the unhedged version of the index returned 4.25 per cent.

Bresnahan says most funds in the SuperRatings survey partially hedge their currency exposure, typically 26 per cent to 50 per cent of international portfolios.

The head of investment consulting for Mercer, Graeme Mather, says many funds have reduced their level of hedging to about 35 per cent to take advantage of a potential winding back of the Aussie dollar. This has taken gloss off returns but may pay off if the dollar depreciates.

http://www.smh.com.au/money/super-and-funds/reap-the-fruits-of-your-labour-20110510-1eg2p.html

Major Delusions among New Graduates

Major Delusions
By TALI SHAROT
Published: May 14, 2011

THIS month American college seniors will don caps and gowns. As they await receipt of their diplomas, they will absorb lessons handed to them by the accomplished men and women who deliver commencement speeches. More often than not the speakers will be outliers: rare individuals who made it against all odds. More often than not their message will be “dreams come true ... take chances ... if you try hard enough you will succeed.”

“Don’t know that you can’t fly, and you will soar like an eagle,” Earl E. Bakken, founder of the medical technology company Medtronic, told the University of Hawaii’s class of 2004. “You have to trust that the dots will somehow connect in your future,” Steven P. Jobs told Stanford’s 2005 graduates.

But in an era of unemployment, financial meltdowns, political unrest and natural disasters, is this message of optimism helpful?

By and large, the answer is yes. Although the graduates are unlikely to be as fortunate as their commencement speakers, evidence from the science of optimism indicates that believing in their optimistic message will nonetheless be a good thing.

We now know that underestimating the obstacles life has in store lowers stress and anxiety, leading to better health and well-being. This is one reason optimists recover faster from illnesses and live longer. Believing a goal is attainable motivates us to get closer to our dreams. Because of the power of optimism, enhancing graduates’ faith in the American dream by presenting them with rare examples as proof may be just what the doctor ordered. Their hopes may not be fully realized, but they will be more successful, healthier and happier if they hold on to positively biased expectations.

Surveys show that students expect to receive more job offers and higher salaries upon graduation than they wind up getting. They anticipate being married till death do them part, though they are acutely aware that statistics say there’s a good chance they won’t be. They underestimate their likelihood of suffering from cancer, heart attack and other misfortunes and overestimate their likelihood of acquiring wealth and professional success. The list goes on and on.

It’s not just the young who embrace positive delusions. Whether you are 9 or 90, male or female, of African or European descent, you are likely to have an optimism bias. In fact, 80 percent of the world does. (Many believe optimism is unique to Americans; studies show the rest of the world is just as optimistic.)

In fact, the people who accurately predict the likelihood of coming events tend to be mildly depressed. The rest of us systematically fail when interpreting the crystal ball.

For many years, scientists were puzzled by the existence of this unshakable optimism. It did not make sense. How is it that people remain optimistic even though information challenging those predictions is abundantly available? It turns out it is not commencement speeches or self-help books that make us hopeful. Recently, with the development of non-invasive brain imaging techniques, we have gathered evidence that suggests our brains are hard-wired to be unrealistically optimistic. When we learn what the future may hold, our neurons efficiently encode unexpectedly good information, but fail to incorporate information that is unexpectedly bad.

That’s why when we listen to Oprah Winfrey’s rags-to-riches story our brain takes note and concludes that we too may become immensely rich and powerful one day; but when told the likelihood of being unemployed is almost 1 in 10 or of suffering from cancer is over 1 in 3 we take no notice.

Such optimistic illusions, with all of their advantages, unfortunately come at a price. Underestimating risk makes us less likely to practice safe sex, save for retirement, buy insurance or undergo medical screenings.

In some cases relatively minor biases can even lead to global disaster. Take the financial crisis of 2008. Each investor, homeowner, banker or economic regulator expected slightly better profits than were realistically warranted. On its own, each bias would not have created huge losses. Yet when combined in one market they produced a giant financial bubble that did just that.

As the Duke economists Manju Puri and David T. Robinson suggest, optimism is like red wine: a glass a day is good for you, but a bottle a day can be hazardous. The optimal solution then? Believe you will live a long healthy life, but go for frequent medical screenings. Aspire to write the next “Harry Potter” series, but have a safety net in place too.

At a time when the economic crisis is deepened by revolutions and tsunamis, cautious optimism may be the most useful message to communicate to graduates — believe you can fly, with a parachute attached, and you will soar like an eagle.

Tali Sharot, a research fellow at the Wellcome Trust Center for Neuroimaging at University College London, is the author of “The Optimism Bias: A Tour of the Irrationally Positive Brain.”

http://www.nytimes.com/2011/05/15/opinion/15Sharot.html?_r=1&hp

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