Diversifying and cutting costs with ETFs
November 24, 2015 | Robin Bowerman, Vanguard Investments Australia
It has been called adviser's alpha. This is the value that quality financial advisers can add by advising their clients on the fundamentals of sound wealth management.
Such fundamentals include setting an appropriate asset allocation and diversification for a portfolio, minimising investment management costs, maximising a portfolio's tax efficiency and adopting a long-term, disciplined approach to investing.
Adviser alpha has nothing to do with trying to beat the investment markets.
The Adviser Products and Marketing Needs Report: August 2015 - recently publicly released by researcher Investment Trends - confirms that advisers are giving a greater priority to portfolio diversification and cost effectiveness - two of the core contributions to adviser's alpha.
Further, Investment Trends found that financial planners are increasingly turning to exchange traded funds (ETFs) and traditional index funds to provide that desired diversification and low-cost investment management to their clients.
The study, which is based on a survey of 676 financial planners, primarily focuses on asset allocation trends.
The key findings in the report include:
Planners are increasingly favouring unlisted managed funds and ETFs for new client investments, and "moving away from stock picking”.
The "war chest” of short-term cash held by the clients of financial planners is decreasing as planners and their clients seek growth in a low-rate environment.
Planners placed 39 per cent of new client investments in international assets over the 12 months to August - up from 33 per cent for the previous 12 months. This is the highest level since the inception of this particular Investment Trends study and is despite the fall in the value of the Australian dollar.
Planners placed 15 per cent of new client investments into index managed funds, including ETFs, over the 12 months to August. Again, this is the highest level since the inception of the study.
During difficult markets in particular, many astute investors concentrate with the guidance of their advisers on the aspects of investing that are within their control. These include their portfolio's asset allocation, diversification and cost efficiency, which are, interestingly, critical factors highlighted in the Investment Trends study.
Certainly, investors have no control over the emotions of other investors, interest rates and market movements. However, they can ensure that their own investment decisions are not emotionally driven and are based on working towards their long-term goals.
What goes up might come down
November 24, 2015 | Robin Bowerman, Vanguard Investments Australia
'Compound interest is the eighth wonder of the world. He who understands it, earns it ... he who doesn't ... pays it.' - Albert Einstein
Time can be both friend and foe for investors.
It is your friend when there is time for the arithmetic of compound interest to work in your favor - or the ability to tune out a major market shock because the time that you plan to retire still can be measured in decades rather than months.
Whether you agree or not with Einstein about compound interest being the eighth wonder of the world, what cannot be disputed is the snowball effect that comes when you receive interest not only on your original investment but also on any interest, dividends and capital gains that accumulate.
Within superannuation there is the added boost that comes from the concessional tax treatment.
The maths of compounding is compelling and well demonstrated by the calculator on ASIC's Moneysmart site. Consider the case of two young people looking to build up savings for financial independence.
She invests $10,000 initially and adds $100 a month over 10 years. The interest rate is 5 per cent. At the end of the period it has grown to $31,998.
He defers savings for five years but then invests $10,000 but saves $200 a month.
They have both invested the same amount -$10,000- and added regular deposits of $12,000. But the extra five years of compounding interest means she has $31,998 to work with while he has to be satisfied with $26,435.
Time is the differentiating factor in this simple example. When it comes to superannuation the compounding is effectively baked in because the basic savings rate is mandatory and the funds are not accessible until you hit retirement.
So let us consider someone with 30 to 35 years of working life ahead of them until they hit retirement age. It is the asset allocation decision that will drive most of the portfolio's return and it is the time horizon that provides a level of freedom to add risk in the form of growth assets to a portfolio with the objective of capturing higher returns over the long run.
The bank cash rate is effectively the risk-free rate of return and when you look at Vanguard's index chart over the past 30 years the cash rate will have delivered you a 7.5 per cent return. By contrast Australian shares have delivered 10.8 per cent return over the same time period while international shares has delivered an 8.6 per cent return.
The difference between the cash returns and what share markets delivered at first glance might not appear that dramatic - particularly when you consider the extra risk and volatility of share markets in the past 30 years.
But thanks to the magic of compounding a $10,000 initial investment in Australian shares grew to $215,685, international shares to $118,257 while cash earnings compounded to be worth $86,815.
While the headline returns between the cash rate and the equity returns may not seem that different the critical issue is the wide spectrum of risk covered.
This is where investors need to choose the asset allocation and blend riskier asset classes with more conservative or defensive investments like cash and fixed income to suit their personal circumstances and risk appetite.
Typically younger folks can afford to take on more risk while people nearing retirement need to throttle back risk and focus more on capital security and income stream.
One of the more positive developments out of the public debate about the state of the superannuation system in recent years is the increasing focus on how the system can deliver better retirement income solutions.
Putting costs aside for the moment, the accumulation part of the Australian super system as it is now structured under the MySuper default deserves its position in the top rankings of pension systems globally.
However, while getting people to save a lump sum for retirement is an essential first step for any retirement savings system, simply leaving them to their own devices when they get there is likely to fall short in terms of achieving the best possible outcomes for fund members in retirement.
That was a key finding of the Financial System Inquiry chaired by David Murray and recently accepted by the federal government.
Recent research suggests that the average retirement age for men is 58 and 50 for women. If you were unlucky enough to retire just before the global financial crisis and your super was in a growth portfolio, then your retirement savings would have taken a significant hit. Academics describe this as sequencing risk.
In the real world, the need to withdraw regular amounts from your savings in order to pay the bills and put food on the table is when compounding becomes a negative. As you incrementally withdraw funds, you have less working to compound in your favour.
While markets recovered over the two years following the GFC an account balance that was being reduced by regular withdrawals effectively took a double hit.
This is not to suggest that at the point of retirement everyone should move their asset allocation on to an ultra-conservative footing such as cash or term deposits. Realistically, most people do not have super account balances large enough to not need some level of growth assets.
There are a range of strategies open to retirees to help manage both longevity (the chance you outlive your money) and investment risk.
Some financial advisers, for example, like to set aside about two years of living expenses in a cash fund to avoid the need to be a forced seller of assets in the event of a major market downturn. Others use a blend of income products like annuities to provide some level of income guarantee.
We are healthier and on average living longer - which is a good thing.
The wild card is we do not know how long we will live and therefore how long we need our money to last. Somewhat paradoxically, the evidence suggests that many retirees may be living overly frugal lifestyles because of the fear of exhausting their savings.
The debate on retirement income clearly has some way to run in terms of public policy settings - and may not affect today's retirees in any case.
That leaves those either in or approaching retirement today needing to navigate their own course to a large extent. If you can find specialist, professional advice to help advise and coach you through such a critical juncture, that is time and money worth investing. A good many self-managed super fund trustees are already forging the path here.
While Einstein suggested taking the time to understand compound interest what may be more appropriate for today's retirees is to understand the power of the asset allocation decision to match investment risk with your own, unique time horizon.
The purpose of super from another angle
November 10, 2015 | Robin Bowerman, Vanguard Investments Australia
Just as the Federal Government accepts a recommendation from the Financial System Inquiry that the objectives of super be enshrined in law, the Superannuation Complaints Tribunal has discussed this issue specifically from the perspective of super death benefits. It makes interesting reading.
The headline for a lead commentary in the tribunal's recently-released 2014-15 report clearly makes its point: Death benefit trap: Superannuation is not an asset of the estate.
A common shorthand definition of the sole-purpose of superannuation reflecting the Superannuation Industry (Supervision) Act is that it is to provide retirement benefits for retirees. And the Financial System Inquiry, chaired by David Murray, states that the purpose of super is to "provide an individual with an income in retirement".
And understandably, given its role, the Superannuation Complaints Tribunal goes further than the shorthand definition to state: "Broadly speaking, the purpose of superannuation is to provide income in retirement to members and their dependants; it does not form part of a person's estate."
As the tribunal suggests, it is a common misconception that super death benefits automatically form part of a deceased member's estate.
Keep in mind that a large proportion of the tribunal's workload involves disputes over how super fund trustees distribute super death benefits (comprising super saving and life insurance benefits).
In 2014-15, 28.7 per cent of complaints within jurisdiction received by the tribunal concerned super death benefits. This compares to 49.2 per cent about fund administration and 22.1 per cent concerning disability insurance.
From the viewpoint of the tribunal in regard to super death benefits, a key word is "dependants".
"Accordingly," the tribunal explains, "a superannuation death benefit should be paid to dependants [of the deceased member] and those who had a legal or moral right to look to the deceased member for financial support had they not died."
It should be emphasised that a fund member can make a binding death benefit nomination, if provided for in a fund's trust deed. The binding nomination could stipulate that a super fund pay death benefits to a member's dependents (as defined in super law) or to a legal personal representative (in other words, deceased estate).
Significantly, a valid binding death benefit nomination removes a fund trustee's discretion regarding the distribution of super death benefits.
One of the indirect benefits flowing from the widespread discussion of late about the purpose or objective of superannuation is that it helps focus the minds of individual members on the purpose of their super savings.
Counting the cost of 'grey' divorce
November 10, 2015 | Robin Bowerman, Vanguard Investments Australia
One of the saddest personal finance stories of the year is a recent piece in The New York Times about the growth of what the author calls "silver or grey divorces".
These divorces involve couples who have been married or in a de facto relationship for 30 years or so who make a decision to separate when close to their retirement or in early retirement.
The article quotes statistics from the National Centre for Family and Marriage Research in Ohio stating that people aged over 50 were twice as likely to divorce in 2014 than in 1990. And the increase was even higher for those aged over 65.
How does the Australian experience with grey divorce compare?
The latest-available divorce statistics from the ABS show that the rate of divorce among those aged over 55 has increased by 80 per cent for men and 68 per cent for women during the 20 years to 2013.
It should be emphasised, however, that the average age for divorce in Australia was 43.5 years in 2013 - up from 37.9 years over two decades.
Certainly, the rate of divorces becomes lower as couples age. Yet the statistics indicate that while divorce rates have tended to plateau for middle-aged and younger couples, the rate of divorce for those over 55 has risen.
Overall, ABS statistics based on marriages and divorces in 2013 suggest that more than 40 per cent of marriages will end in divorce. (Significantly, none of these divorce figures include de facto relationships.)
Sadly, one of the greatest destroyers of personal wealth is the breakdown of marriages and de facto relationships.
Separation means that a former couple's assets - including the family home, their superannuation and their other investments - are split. Solely from a retirement perspective, a relationship breakdown means that not only are retirement savings divided but each person has to pay for separate accommodation.
Many separated individuals, of course, can no longer afford to own a home. And the reality is that it typically costs much more to finance the retirement of two single people than a couple.
Further, it can be extremely difficult for separated older spouses to rebuild their retirement savings. And this task can be even tougher for an individual if his or her partner had much of the control over family finances during a long relationship.
With the rapid ageing of the population together with seemingly ever-increasing longevity means that the rate of divorces among retiring baby boomers is likely to keep climbing.
This expectation underlines the desirability maximising retirement savings while still in the workforce and for both partners in a relationship to save as much as possible in super.
Sound personal financial practices include preparing for the unexpected and gaining quality professional advice when appropriate.
Intergenerational challenges for retirement saving
October 28, 2015 | Robin Bowerman, Vanguard Investments Australia
A potential trap when saving for retirement is to automatically assume that our retirement savings will have to cover just ourselves: either as a couple or as a single retiree. Yet as many more people nearing retirement or already in retirement are finding out, life and family circumstances can be far more complicated than that.
Greater longevity with improvements in medical science and the wave of retiring baby boomers are among the fundamental causes for the apparent growth of what has been called the "dual-retirement" or "common-retirement" phenomena. This is said to occur when two generations of the same family are in retirement at the same time.
The New York Times quoted Phyllis Moen, a sociological professor at the University of Minnesota, earlier this year as saying that it is "historically unprecedented [until now] where you have older people and their still-older parents".
In turn, this is leading to intergenerational demands on retirement savings as retired baby-boomer retirees provide some financial assistance to their very elderly parents.
And to make retirement savings and retirement budgeting even more complicated, there is also the so-called "sandwich generation". Members of this generation - typically in their fifties and sixties - are still providing at least some financial assistance to their adult children as well as their own elderly parents.
Indeed, some members of the sandwich generation are retired themselves.
Several major publications have published articles this month examining some of the inter-generational complications facing countless baby boomers and their retirement savings.
A New York Times personal finance feature, Reopening the Bank of Mom and Dad to Help Adult Children, discusses the case of a 55-year-old teacher who is using some of her retirement savings to provide extensive financial support to an adult child. This means she will have to work longer before retirement or sell her home (already being used as collateral for her daughters' student loan).
The article's author asks several financial specialists about how parents should handle their financial dealings with their adult children. In short, they emphasise that parents should not sacrifice their own financial future to subsidise an adult child's lifestyle. And any loans should be made on a formal basis with a contract providing for the payment of interest and the repayment of capital.
Also this month, Forbes magazine published an article, A New Generational Struggle: Sandwiched Between Ageing Parents and Growing Children. "Members of the sandwich generation are often unaware of their parents' financial situation and assume that their parents are prepared for their 'golden years'," the writer comments.
Vanguard in the US published a highly practical article two years ago headed Your Investing Life: Helping Ageing Parents, examining how adult children can help their ageing parents while not neglecting their own needs. Its suggestions include:
- Try to find out about your elderly parents' financial position while respecting their "financial boundaries".
- Make sure your parents are aware of their government entitlements.
- Take any necessary steps to protect your parents from financial fraud, which is often targeted at the elderly.
"If your parents are under financial constraints, you may want to tap into your retirement savings to help them," Vanguard's specialists write. But while is an "admirable instinct", it could have long-term financial consequences for you. "Consider any such move carefully before you act."
A skilled financial adviser could be well-placed to provide guidance about how to handle the intergenerational challenges for our retirement savings.
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