More retirees getting financial advice – and incorporating protection strategies into portfolios – would enhance investment outcomes.
By Caitriona Wortley, Allianz Retire+
The rally in Australian shares this year and forecasts of rising house prices suggest good times are back for investors.
That might be true for growth investors seeking capital gains. For income investors who live off their portfolio’s yield, times have never been tougher.
In fact, all Australian investors face the biggest problem ever seen in markets: record-low interest rates that are punishing savers and distorting asset valuations.
Nobody is more affected by low rates than retirees. Term deposit rates have fallen 97 per cent since the 2007-08 Global Financial Crisis to 25 basis points (RBA, June 2021)1
In dollar terms, a pre-GFC retiree with $1.25 million in term deposits could generate around $103,000 of risk-free annual income without touching their capital (based on a term deposit rate of 8.25%). Today, the same retiree can generate only $3,125 of income from that investment, based on an term deposit rate of around 0.25% (RBA, June 2021)2
Worse still, a retired couple today would need around $25 million invested in cash to fund a comfortable standard of living at the current average term deposit rate of around 0.25%p.a. (RBA, June 2021; ASFA Comfortable standard of living, March 2021)3
Retirees who invested the bulk of their savings in cash and term deposits in the past decade could have suffered immense financial damage (in real terms). Sadly, many retirees have adapted to lower returns by downgrading their living standards.
Our industry cannot and should not accept this. Inertia is not an option. Nobody wants retirees investing most of their savings in cash and term deposits because they are fearful of either losing or running out of their money.
I believe two behavioural shifts could improve retirement investing and enhance living standards for many older Australians. Neither should require complex regulatory change.
The first is financial advice. Our industry must encourage more retirees to seek financial advice much earlier in their investing journey. We know that Australians who have financial advice are in a significantly better position than those who try to go it alone.
Yet only about one in five people who planned to retire last year was likely to pay for financial advice4. This means about 351,000 Australians (of approximately 438,000 who planned to retire5 will not have paid financial advice.
The result? Too many unadvised retirees will park the bulk of their savings in cash and term deposits and earn a negative return (after inflation). Their wealth potentially going backwards.
Some retirees will automatically roll over term deposits year after year, even though cash returns are falling. Or worse, make major asset-allocation shifts after a market shock – such as moving entirely to cash after the GFC – and never getting the courage to return to markets because they fear sharemarket volatility.
The second change relates to how advisers build the defensive component of portfolios in retirement. In a low rate environment, with an aging population, the traditional 60/40 model of portfolio allocation is on life support.
Consider a portfolio with 60 per cent in growth assets and 40 per cent in defensive assets. The current, very low returns from defensive assets means that 40 per cent of the portfolio is simply not earning enough return. If a retiree is then drawing SIS payments of 4, 5, 6 or 7% p.a., they could very well be going backwards. In this scenario, there is certainly a strong argument to introduce more growth assets.
But with growth assets comes greater volatility – a retiree’s worst nightmare. According to Callan Associates research, for investors to earn a 7.5 per cent return 30 years ago, they could have done so with no exposure to growth assets and a standard deviation of 3.1%. In 2019, to earn that same return, the exposure to growth is set at 96 per cent with the standard deviation skyrocketing to 18 per cent6.
Put simply, portfolios must contend with six times as much volatility to earn around the same return as 20 years ago. If you consider the fact that retirees are about five times more loss averse than the average investor7, my guess is it would be rare to find a retiree who can stomach that kind of volatility and sleep easy at night.
To increase returns in this environment, investors may be taking bets on the defensive side of the portfolio, increasing duration, credit risk or other risks within portfolios. But in many cases, this makes the assets more akin to growth and subject to significant volatility – a fact that would likely be a shock to many retirees.
The question then becomes:
“how can the 40 per cent in defensive work harder to deliver greater returns without excessive risk?”
It was this very thought that identified a need for a low-cost, protected retirement product that enabled advisers to choose an appropriate level of protection for their client.
Protected retirement products are not just for growth allocations in portfolios. Increasingly, advisers are using such products as a sleeve in a portfolio’s defensive allocation. Such advice innovation is needed to help retirees lift income returns without adding significant extra risk to portfolios.
By using a protection strategy with a 0% Floor (zero loss tolerance), a retiree could earn a maximum potential return of 2.55%p.a8., with a maximum downside of -0.8 per cent p.a8. potentially using a protected retirement strategy in the defensive allocation could earn ten times that amount9.
Of course, that is only part of the answer in a low-rate environment. Protection strategies are not risk free and can involve long term products that discourage individuals from withdrawing their investment early. But the next time a retiree walks through an adviser’s door, it may serve to ask: “What does the retiree really want from his or her retirement savings? And what investment tools are readily available for advisers to meet that need?”
Research consistently shows Australian retirees want financial advice that helps them feel more confident in retirement. They want better returns than those currently on offer, but they have limited appetite to dial up their risk exposure in order to achieve it.
Most of all, retirees want to sleep easy at night, knowing their savings won’t run out when they need it most. That requires an element of certainty and protection, but financial advisers have had few such tools available to provide this. Previous protection products were too costly, complex or required too much upside to be given away.
Change is coming. More retirees getting advice – and using protection to safeguard wealth and enhance income – may make a huge difference. Imagine what a potential extra 1-2 per cent return on portfolios could do for retirees. In this market, every extra percentage point counts.
1 Reserve Bank of Australia: Retail deposit and investment rates; Banks’ term deposits ($10000); 1 year, at May 2021, issued 2 June 2021 [and using July 2008 term deposit rate of 8.25%]. https://www.rba.gov.au/statistics/tables/?v=2021-04-30-07-17-25#interest-rates
2 Reserve Bank of Australia: Retail deposit and investment rates; Banks’ term deposits ($10000); 1 year, at May 2021, issued 2 June 2021 [and using July 2008 term deposit rate of 8.25%].
3 Assumes average term deposit rate of 0.25%. Uses Association of Australian Superannuation Funds (ASFA) Retirement Standard of $62,828 in annual living costs for a retired couple who want a “comfortable lifestyle”. ASFA standard at March quarter 2021. Retirement Standard – ASFA (superannuation.asn.au)
4Financial Planning Association of Australian estimates.
5Retirement and Retirement Intentions, Australia. Australian Bureau of Statistics, 2018-19.
6Planning Association of Australian estimates.
7Callan Associates, “Risky Business”, 2019
8Based on Allianz Retire+ Future Safe seven-year investment interval, 0% floor, 50/50 investment into S&P/ASX 200 Total Return (3.50% Cap) and MSCI World Net in AUD (3.20% Cap) indexes at June 2021. Net of 0.80% pa fee. This example uses past-performance data, which is not a reliable indicator of future performance and is no guarantee of future returns. The returns on the Future Safe product issued by Allianz Australia Life Insurance Limited ABN 27 076 033 782, AFSL 296559 (Allianz Retire+) which are used in this example are subject to a number of variables including investor elections, market performance and other external factors, and may differ from this example. Prior to making an investment decision, investors should consider the Product Disclosure Statement (PDS) which is available on our website (www.allianzretireplus.com.au).
9Reserve Bank of Australia: Retail deposit and investment rates; Banks’ term deposits ($10000); 1 year, at May 2021, issued 2 June 2021.