June 04, 2015 | Robin Bowerman, Vanguard Investments Australia
All of us expect to slow down as we age, affecting many aspects of our lives. Our ability to deal with money is obviously not immune from the relentless march of ageing.
Indeed, a recent personal finance feature in The New York Times points to research over the years showing that our capability to handle our money is one of our first skills adversely affected by age.
Australia's recent 2015 intergenerational report underlines just how our quickly our population is ageing - in line with a trend being experienced in much of the world.
Ageing and money are, of course, are closely related issues. First, we aim to save for retirement and old age while still working. Next, we face the challenges in retirement of protecting those savings as well as managing our everyday budgets when no longer receiving an employment income.
In the NYT feature - As cognition slips, financial skills are often the first to go - journalist Tara Bernard interviews medical, economic and financial planning specialists about the impact of ageing on an individual's capability to handle personal finances.
For instance, neuropsychologist Daniel Marson provides a useful tip to assist an older person you care about: "If you can detect emerging financial impairment early, you can also step in early and protect that person."
Dr Marson has written a paper - funded by the National Endowment for Financial Education and the National Institute on Ageing in the US - giving some "early warning signs of financial decline".
These warning signs include an older person concentrating too much on the potential benefits of an investment and not enough on the risks, and having more difficulty with day-to-day financial matters such as paying bills and calculating restaurant tips.
A decline in a person's ability to handle finances makes them more vulnerable to making poor investment decisions, falling for investment scams, and agreeing to hand over money or control of their finances to unscrupulous individuals.
MoneySmart, ASIC's personal finance website, has a recently-updated feature giving fundamental pointers about looking after money as we age. Significantly, the article discussed the sometimes sensitive subject of family involvement in an older person's finances.
"While it can be helpful to get the opinions of your family and friends on financial matters," according to MoneySmart, "you need to think carefully about giving away any power over your investments. Sometimes older people can find themselves being pressured by family or friends to hand over control of their money or property."
Such concerns highlight why it can be so critical for older people to gain ethical, high-quality and independent professional advice together with the support and guidance of trusted friends and family members.
Advisers can discuss such matters as whether an investment portfolio should be simplified as a person ages and whether their portfolio's target asset allocation is still appropriate given their changing circumstances and expected longevity.
Other issues to possibly discuss with an adviser include estate planning and whether or not to have an enduring power of attorney, which grants authority to another person to make financial decisions on their behalf including if mental capacity is lost.
An investor's challenge
June 04, 2015 | Robin Bowerman, Vanguard Investments Australia
An elementary challenge for investors is to decide whether to invest in actively-managed investment funds, index-tracking funds or a combination of both.
Investors face this challenge when investing in their own name, through a self-managed super fund, a large super fund offering an index investment option, a family trust or in another way.
Some investors respond to the challenge by adopting a core-satellite approach. This typically involves holding the core of a portfolio in low-cost traditional index funds and/or exchange traded funds (ETFs) tracking broad share market indices such as the S&P/ASX 300 index and the MSCI World ex-Australia Index.
In turn, investors following core-satellite approach typically hold smaller "satellites" of favoured actively-managed funds and directly-held investments such as shares.
Vanguard in the US has published the latest version of a key investment brief, The case for index-fund investing, that explains the relative characteristics of index funds and actively-managed funds.
As part of their research, the report's authors - Christopher Philips, Francis Kinniry, David Walker, Todd Schlanger and Joshua Hirt - examined how a range of actively-managed funds available to US investors (US and non-US share funds and US fixed-income funds) performed against their stated benchmarks over the short and long term to December 2014.)
Critically, the researchers assessed fund performance on an after-fee basis, using Morningstar data. And the researchers analysed fund performance over one, three, five and 15-year periods.
Their research paper, which builds upon previous research in the US and in Australia, had a clearly-stated objective: "to explore the theory behind indexing and to provide evidence to support its use". (For further reading, see The case for indexing in Australia (PDF), a research brief published January 2013 with a focus on Australian equities and fixed interest.)
The latest paper opens with a straightforward explanation. "Indexing is an investment strategy that attempts to track a specific market index as closely as possible after accounting for all expenses incurred to implement the strategy".
As the researchers write, "this objective [of index funds] differs substantially from that of traditional investment managers whose objective is to outperform their targeted benchmark even after accounting for all expenses".
The words "even after accounting for expenses" are particularly significant because higher fees handicap an active manager's ability to even match its chosen index.
In essence, the researchers show that:
- The average actively-managed fund among those surveyed underperformed various benchmarks including their own. "To take one example, 72 per cent of US large-cap value equity funds underperformed their benchmarks over the 10 years ended December 31, 2014." The case for indexing also tended to be strong over longer and shorter periods.
- Reported average performance for actively-managed funds can "deteriorate markedly" once no-longer-surviving funds are included in the comparisons. (Funds that don't survive usually merge with other funds or close following poor performance.)
- Persistence of continuing strong performance among past top-performing, actively-managed funds is "no more predictable than a flip of a coin".
A central message for investors from the research is that low-cost index funds have a greater probability of outperforming higher-cost, actively-managed managed funds - "even though index funds generally under-perform their targeted benchmarks [after costs]".
Whatever... money management teenager style
May 12, 2015 | Robin Bowerman, Vanguard Investments Australia
Teenagers can be a worry - just ask any parent. But when it comes to understanding all things financial, today's teenagers have to deal with a much more complex and in many ways less tangible world.
Unusual indeed is the teenager today without a mobile phone - and the financial risks that come along with big data bills - while the world of online banking, debit and credit cards is just a login away.
That is before you get into the world of eftpos and the rapid convenience of paywave technology that makes it so, so easy to grab the extra bits and pieces you feel you need right then and there.
The paywave convenience may not just be a trap for teenagers but older folks generally should, with experience, have more awareness of what they can afford and know when they are perhaps living beyond their means.
Budgeting is a much underrated financial skill but teenagers in today's modern electronic world can be excused for not always connecting the dots.
At the risk of this becoming a grumpy old man column, back in my teenage years budgeting was not optional.
If you did not get to the bank before 3pm on Friday afternoon you couldn't drink beer on Saturday night. You also learnt that if you spent big on Friday night then you would not be drinking beer on Saturday night.
Such were the realities in a much simpler world.
The concept and impact of budgeting was a lot easier to understand when you just had to check how much cash was in your wallet to know how your budget was tracking.
Which is where the power of the old-fashioned paper bank statement can be put to good use - if you can get the teenager to open something as old-school as a letter.
But a new bank account - with new debit/credit card - plus motivation for a savings strategy did prompt the unsealing of a bank envelope in the Bowerman household recently.
Full credit to the bank involved because the statement layout showed in big letters not just the closing balance but also the amount of money that had gone into the account and the amount that had gone out.
The total amount that had gone out hit home and sparked a robust dinner table discussion.
Suddenly lunches with friends, coffees after school and so on were seen in a much more meaningful fiscal light.
Habits - allegedly - are about to change.
But the online world where teenagers are the first true native inhabitants can also be part of the solution as well as fuelling the problem.
Certainly you can get statements via email, online alerts about credit card payments can be sent, balances can be checked on the run as easily as a paywave.
But there are also an array of phone apps that help track expenditure and more importantly perhaps prompt good savings habits.
Most of these are commercial in one form or other but a recent visit to the ASIC MoneySmart website prompted the download of their recent Track My Spend app. While it may not win awards in the uber cool app design world, it gets plaudits for its functionality and is a simple, easy to use tool that lets teenagers and those a little further advanced in years to track spending over short periods like a week or further out on a fortnightly, monthly, annual or custom date range.
Best of all it is using the teenager tool of choice - the smartphone.
The corporate regulator's MoneySmart website is a resource that has been built up over many years and it comes with the credibility of being delivered out of the offices of the nation's corporate regulator as part of its effort to boost financial literacy.
There is a companion Track my Goals app to go along with the spend tracking tool that is also available free to download.
The MoneySmart site is a great resource not just for the apps mentioned but also for more detailed educational material and also investor alerts and warnings. All of which can help set up young investors - or those just young at heart - for investing success over the longer term.
Reinforcing benefits of total-return investing
May 12, 2015 | Robin Bowerman, Vanguard Investments Australia
The Reserve Bank's cutting of official interest rates to a record low of 2 per cent should reinforce to income-focused investors why the concept of total-return investing makes sense.
In short, total-return investing involves investing for both cash flow and capital appreciation.
And under a total-return approach, investors needing more income to finance their lifestyles than generated by their portfolios draw down against their portfolio's capital appreciation.
By taking a total-return approach, investors should be less tempted to chase yields by reducing exposure to high-quality fixed income and broad share portfolios to increase their allocation to higher-risk bonds and more concentrated high-yield share portfolios.
Unfortunately, not all investors would recognise the higher risks involved when moving away from carefully-constructed and diversified portfolios with asset allocations that reflect their personal tolerance to risk and their long-term goals.
Following the Reserve Bank's latest rate cut, it is worth revisiting a Vanguard research paper, Total return investing: An enduring solution for low yields, published in late 2012.
The paper points out that income-orientated investors have three fundamental choices when yields are historically low: spend less, reallocate their portfolio to higher-yielding investments or spend from total returns instead of income alone.
As the authors - Vanguard analysts Colleen Jaconetti, Francis Kinniry and Christopher Philips - say, "spending less is generally not a desirable option for most investors".
Regarding any temptation to reallocate a portfolio to higher-yielding investments, Jaconetti, Kinniry and Philips write:
- Investors who shift some of their fixed-income portfolio into higher- dividend shares carry the risks of high volatility and potential for significant capital loss. "Clearly, for an investor who views fixed-income as not just providing yield but also diversification, dividend-paying stocks fall well short".
- High-yield bonds are both more highly correlated with the equity markets and more volatile than investment-grade bonds.
A critical role of quality bonds is to act as portfolio diversifier or ballast for a portfolio - not solely to produce income. This should not be overlooked in a very low interest environment.
Asset allocation through the ages
April 16, 2015 | Robin Bowerman, Vanguard Investments Australia
The majority of members of super funds have their retirement savings in the default or MySuper options. This is both a strength and weakness of the Australian superannuation system.
The weakness manifests itself because with mandatory contributions and default options there are low levels of member engagement with their retirement savings.
That is not to say that everyone in the default options is disengaged - a number certainly will have decided that the default option's asset allocation suits them just fine.
The interesting question is whether the asset allocation of a typical default fund suits members at any age.
Age is clearly a powerful filter for investment decision-making. Financial advisers are prone to say that if they had to build a financial plan based only on one piece of information that your age would be that critical data point.
So consider two super fund members. One is 25 years old and has started their first full-time job, the other has just celebrated their 64th birthday and is planning their life after full-time work about a year from now.
Both are invested in the same fund's default balanced option and therefore have exactly the same asset allocation for their super savings.
Yet our 25-year-old has an investment horizon that could feasibly stretch over 70 years. Our near retiree realistically has a time horizon in the 20-30 year range.
And along with their age difference is their ability to recover from severe market shocks like a global financial crisis. For the 25-year-old a GFC like event would barely show up as a blip on their fund's performance chart as they approach retirement in 50 years time. For the 64-year-old the consequences and impact of a GFC event on their retirement lifestyle could be much more immediate and dramatic as they enter the drawdown years.
Now each person can choose to move away from the default by opting for one of the other risk-based portfolios – typically ranging from conservative or stable to high growth – and align their asset allocation more closely with age and therefore risk profile.
But human nature being what it is most people do not do that.
A new generation of default options are emerging in the Australian market where the asset allocation is driven by the age of the member rather than targeting a certain level of risk for the portfolio investment mix.
So-called target-date or lifecycle funds are increasingly becoming the dominant choice for default portfolios in markets like the US 401(k) system which is comparable to our own defined contribution superannuation system.
Vanguard in the US is a major provider of 401(k) record-keeping and investment services and has seen the use of target-date funds rise from about 2% back in 2005 to about 40% in 2014 and forecasts that 63% of members in the 401(k) plans will be invested in them by 2019.
It must be said that the Australian system's starting point of investing in default funds taking a balanced portfolio approach was much better than the US system where a money market or cash fund was a common default.
A number of different methodologies have been developed for the target-date approach. Vanguard's approach is to segment investors into four distinct phases.
Phase 1 includes younger investors (under 40) where a higher allocation to equities – around 90 per cent - is used. Phase 2 sees the asset allocation move to a 50/50 split between growth and income investments for people aged 41-65 which is much more akin to current balanced defaults.
Phase 3 is when investors are in the early years of retirement and again the asset allocation to riskier assets is reduced, while phase 4 is when members are in the later stages of retirement although there remains a modest exposure to equities within the portfolio.
The target-date approach is simply providing an automatic approach to dialing down market risk as the member ages and recognising that capital preservation increases in importance as we get older and particularly after we have stopped full-time work.
Self-managed super fund trustees may question how relevant these types of default options are to them but the same challenges apply. The aim is avoid extreme asset allocation decisions – either too aggressive or overly conservative – and the impact of poor portfolio construction because of inadequate diversification.
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