July 15, 2015 | Robin Bowerman, Vanguard Investments Australia
First the good news. Millions of Australians gain their life and disability insurance as well as income-protection insurance through their super funds' default cover. And the level of that default cover tends to be much more adequate than a decade ago. Now the not-so-good news. It can be a costly mistake to assume that your super fund's default insurance cover is adequate for your circumstances.
Underinsurance in Australia 2014, a 94-page report published over the past week by Rice Warner Actuaries, estimates that the median default cover provided by super funds cover meets 60 per cent of the life insurance needs for average households. However - and this is a big however - the funds' default death cover meets a much lower proportion of needs for families with children.
Young families with children are calculated to have a "basic level" life insurance need of about $680,000 - $400,000 more than the typical default coverage. (This calculation is based on certain assumptions including that the parents in these families are aged 30.)
Interestingly, half of the $14 billion collected annually in life insurance premiums each year is through super funds for their group insurance cover.
Rice Warner has gathered its superannuation insurance data from 45 industry funds, 14 public-sector funds and six employer master trusts. These funds have a total of 16.5 million members.
The Underinsurance in Australia report makes the crucial point that members' insurance needs "vary significantly" depending upon the composition of their families.
"This could be addressed by superannuation differentiating members' default cover by marital status and the number of independent children instead of just age," the report suggests.
A reality highlighted by the researchers is that the level of default life cover held by the youngest single members of super funds is "likely to be higher than their needs".
Yet the coverage of members as they grow older and form families and accumulate debt typically falls well short of needs.
Rice Warner says the key challenges for super funds in regard to improving the adequacy of insurance cover for their members are to:
- More closely tailor insurance cover for younger people to reduce the possibility of over-insurance given their typically more limited liabilities and responsibilities.
- Maintain insurance for older members. Many super funds' default covers "taper rapidly" as members grow older but their insurance needs may not reduce.
- Encourage members to report to their super funds "life events" such as having children, taking a home loan and older children becoming financially-independent. This would assist super funds to fine-tune insurance products to their members' circumstances.
While these particular pointers are directed at super funds, the report may prompt individuals - perhaps with the guidance of their financial planners - to take the initiative and make sure their insurance is adequate for their family's circumstances.
Perhaps as starting point, consider feeding your family's details into an online insurance calculator provided by large super funds. Also, ASIC's personal finance website MoneySmart has some valuable tips on gaining the right level of cover - inside or outside super. (See Insurance through super.)
One tip is that if you are considering switching super funds to first check whether you will get the same level of life, total and permanent disability and income-protection cover with the new fund - at the right price. This can be particularly critical if you have an existing medical condition.
A core message is not to jump to the assumption that your super fund's default cover is sufficient your circumstances.
Rice Warner's research confirms that the levels of underinsurance for permanent disability and income-protection cover are even greater than for life insurance.
Astute investors are a little like astute kayakers
July 15, 2015 | Robin Bowerman, Vanguard Investments Australia
US financial planner and New York Times columnist Carl Richards remembers a valuable tip he received more than a decade ago when learning to ride a river on a kayak.
The advice was straightforward: Avoid focussing on the rocks and other obstacles. Rather, concentrate on the "space between the rocks".
However, he didn't heed the tip and flipped upside down in the icy river.
In a recent article, Focus on the opportunities, not the shoals, Richards writes that investors experience a similar challenge when trying to maintain their focus despite all of the noise in the market about what could go wrong.
"Unfortunately, devoting all of our attention to the financial rocks," he emphasises, "makes it difficult to see the opportunities we have some actual control over."
Investors have faced a series of financial "rocks" in recent weeks to potentially throw them off course.
Besides the challenge of investing in a low-interest environment, there have been the headlines about the Greek debt crisis, the state of the Chinese share market and the latest iron ore price - to name just three.
In turn, investor concern is being reflected in heightened volatility on world share markets.
While investors can't control the markets or the emotions of other investors, there is plenty they can control.
As discussed in Vanguard's principles for investing success publication (PDF), things that investors can have much control over include:
- Their investment management fees. High fees handicap returns; it's as simple as that.
- The tax efficiency of their portfolios. Frequent trading, for instance, can trigger CGT in addition to extra transaction costs. On the other hand, the concessionally-taxed super system can provide excellent opportunities for greater tax efficiency.
- Their portfolio's long-term asset allocation. Successive research has concluded that a diversified portfolio's strategic asset allocation - the proportions of its total assets invested in different asset classes - is responsible for the vast majority of its return over time. Appropriate diversification spreads both risks and opportunities.
- Their own emotions. Investors who maintain a disciplined, unemotional approach to investing focus on the long-term without being swayed from their course by short-term market movements and the latest media headlines. This makes them less likely to fall into the trap trying to time the market - that is, attempting to pick the best times to buy and sell.
An investor's challenge is to look beyond the financial obstacles or rocks that will inevitably arise along the way.
Saving meets investing
July 06, 2015 | Robin Bowerman, Vanguard Investments Australia
The baby boomer generation are often enviously described as the 'lucky generation'.
Certainly that demographic cohort born after the end of World War II and before 1960 enjoyed a very different economic and social backdrop to their parents and grandparents and that went a long way to changing attitudes to housing, money and retirement.
When it comes to wealth factors the sustained growth in residential property prices in Australia have benefited baby boomers in a significant and material way.
The intergenerational impact of that is increasingly a subject of national debate about whether property prices - at least in Sydney and Melbourne - are showing signs of being an asset price bubble which in turn fuels the discussion of housing affordability and the generational disadvantage that today's younger generation are confronted with.
The baby boomers are not immune from the issue just because they are well-established in the property market. For many there is something of a pincer effect underway. Their adult children are living at home for longer - or perhaps are part of the boomerang effect where the call of independence sees them leave only for them to return a few months later as either financial reality of renting hits home and/or relationship dynamics change.
Then there is the challenge many baby boomers have of helping out ageing parents with accommodation as health issues make independent living more difficult. It has been interesting to read articles recently from architects and builders about the changing demands of house design away from open-plan to more zoned, independent living spaces.
Market forces at work.
Two family friends are a microcosm of the issue. One has just enjoyed celebrating turning 30, is working hard and has a disciplined savings regime going to build a house deposit. But watching house/apartment prices rise faster than savings is a massive disincentive while at the same time a big slice of weekly income for an inner Melbourne unit continues to go out in rent.
The other has just taken the big plunge into property with their first unit/townhouse. It is a long way from their inner city haunt but - as their parents pointed out - it is several levels better than the first house they bought.
Which reminded me of work done a few years back by renowned US economist Professor Robert Shiller.
Shiller developed arguably the best-known US house price index - now known as the S&P Case-Shiller index - so is well-equipped to opine on house price growth and certainly the US experience leading up to the global financial crisis when the market was awash with easy-to-get loans is a scary notion both for someone considering taking the plunge into a large mortgage today as it is for key market regulators like heads of Treasury and the Reserve Bank of Australia.
Shiller, speaking at an investment conference in the US back in late 2008, pointed out that the price inflation in house prices needed to be adjusted for the significant developments in housing technology and costs over the decades since the 1960s. His point was that the modern standard home today offers a lot more accommodation than the average home in the 1960s when the average first home was a very basic, typically two-bedroom form of accommodation.
Contrast that to today where new home developments are routinely are expected to offer three to four bedroom houses standard with ensuites and garages.
This is not saying first home buyers should be satisfied with a two-bedroom fibro shack with outside toilet. Some things are better left in the past but it is hardly surprising today's first home buyers have higher baseline expectations around standard of accommodation and location.
However, it is not all doom and gloom because the younger generation do have a couple of advantages. For a start they have the powerful advantage of time. The other is that they will be the first generation to benefit from superannuation contributions across their entire working life. Although the occasional suggestion that super should somehow be able to be accessed for house deposits would significantly undermine that benefit.
The challenge with property is that it is such an expensive, lumpy, illiquid asset. It also comes with high transaction costs in the form of stamp duty.
The downside of very low mortgage rates are the even lower interest rates being paid on bank term deposits that are barely keeping up with inflation.
House deposits are typically thought of as short-term savings and invested accordingly to avoid risk of capital loss.
Superannuation is a long-term investment and the majority of it is invested in diversified portfolios with a fair portion of it in growth assets. What is perhaps required here is to borrow the idea of greater patience from previous generations and combine it with the modern day approach of investing in superannuation. While super is locked away for retirement there are numerous comparable investment funds outside the superannuation system that offer diversified investment approaches.
Diversified funds typically come in a range of risk profiles - similar to super funds - ranging from conservative to balanced to growth to high growth.
Naturally as you go further up the growth asset spectrum you are adding risk to the portfolio which is why a longer-term horizon is important.
Put another way it is when a savings plan becomes an investment and financial planning strategy.
First experience of ETFs
July 06, 2015 | Robin Bowerman, Vanguard Investments Australia
Some investors will gain their first experience of Exchange Traded Funds (ETFs) through the direct investment options now offered by a number of large commercial and industry super funds.
This may encourage some super fund members to eventually go a step further and establish their own self-managed super fund, perhaps with ETFs as the core investment. Others may find that the direct investment options satisfy their desire for more control over their super investments and decide against setting-up an SMSF.
The offering of ETFs as part of the direct investment options of some large super funds is another step increasing both the popularity and investor knowledge of the products.
Recent ASX research (PDF) shows that the market capitalisation of Australian-listed exchange traded products - comprising Exchange Traded Funds and Exchange Traded Commodities - grew by more than 62 per cent to $18.8 billion over the 12 months to the end of May.
And the market capitalisation of locally-listed exchange traded products increased by 143 per cent or by more than $11 billion over the past two years. (The vast majority of exchange traded products are index-tracking ETFs.)
Typically, direct investment options give members the ability to choose individual stocks from the S&P/ASX 200 or 300, ETFs covering various asset classes (covering Australian and overseas markets) and a restricted number of term deposits. Some direct investment options include listed investment companies among their available investments.
Some large super funds are offering their direct investment options to members in both the accumulation and pension phases.
No doubt, direct investment options will not provide some members with the degree of investment freedom and flexibility they are seeking.
For instance, there are limits with direct investment options on the percentage of a member's super savings that can be invested in each one. Also, some members may want to make their selections from a wider choice of investments than on offer.
Such members may decide to setup a SMSF, perhaps once their superannuation savings are sufficient to warrant their own super funds.
Yet as a superannuation adage goes, SMSFs are not for everyone. And, in the same sense, direct investment options of large super funds are not for everyone.
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.
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