Stretching retirement income
October 12, 2016 | Robin Bowerman, Vanguard Investments Australia
Retirees can face some tough decisions if they find that their retirement income is not stretching far enough, particularly in the prevailing low-interest environment.
A reduction in spending is not really an option for those retirees who are already running a tight budget.
Certainly, some retirees think about returning to the workforce if possible, perhaps on a part-time basis. Continuing to work past traditional retirement ages provides an opportunity to save more for what will be a short and therefore less costly retirement.
In reality, retirees wanting to return to the workforce can struggle to find suitable jobs. And obviously numerous retirees cannot return to work for medical reasons.
Retirees who are finding that the income generated by their super and non-super portfolios (perhaps supplemented by the age pension) may consider seeking guidance from a financial planner about such issues as:
- Making retirement budgets as efficient as possible. Particularly given Australia’s ageing demographics, it is inevitable that more retirees will seek advice on budgeting for retirement and efficiently drawing down on retirement savings.
- Minimising investment costs. By lowering investment management costs, more of an investment’s return is left for the investor.
- Looking at whether to take a total-return approach to investing. Many retirees try to base their retirement spending solely on the income or yield generated by their portfolios. A classic Vanguard research paper, Total-return investing: An enduring solution for low yields, suggests that retirees consider taking both the income and the capital returns of a portfolio into account when setting retirement drawdowns and spending.
- Avoiding taking excessive risks in the pursuit of retirement income. This is linked to the previous point. Some retirees try to prop up income side of their portfolios by reducing exposure to high-quality fixed interest and broadly-diversified share funds to increase exposure to higher-risk, higher-yield bonds and a more-concentrated selection of high-dividend shares.
But by moving away from appropriately-diversified portfolios, such investors may have difficulty in meeting their long-term investment goals given the greater risks involved.
Interesting, recent CSRIO research on superannuation drawdown behaviour – from a team that includes behavioural economist Dr Andrew Reeson – confirms that many retirees in their 60s and 70s draw down on their account-based pensions at modest rates. Often only the minimum pension is taken.
Perhaps it’s a matter of understanding your financial position as a retiree and seeking advice when appropriate.
While some retirees have difficulty stretching their retirement savings far enough, others may be unnecessarily frugal as the CSRIO research suggests.
Effective active comes with a (low) cost
October 12, 2016 | Robin Bowerman, Vanguard Investments Australia
Reading the latest report card on Australia's actively managed investment funds, you could be forgiven for thinking that the profession of 'stock-picking' has had its day.
S&P Dow Jones recently released their mid-year 2016 SPIVA Australia Scorecard and it shows that the majority of actively managed funds have had a hard time lately, with the majority failing to beat their respective benchmarks over one, three and five year periods.
One year, S&P argues, is really too short to draw any meaningful trends from, so it makes sense to look at the longer term over five years.
The S&P research found that 69.18 per cent of active Australian equity funds underperformed the S&P/ASX 200 Index over five years, 91.89 per cent of active international equity funds underperformed the S&P Developed Ex-Australia Large MidCap Index and 88.68 per cent of Australian bond funds underperformed the S&P/ASX Australian Fixed Interest Index.
Those numbers may leave some investors with the impression that actively choosing securities is an inferior method of investing to index-based management, where broad, market cap-weighted funds simply hold a representative sample of an index, like the S&P/ASX 300.
Vanguard is well-known as a leading index manager around the globe, having launched the first retail index fund back in 1976 in the US, and has benefited from the shift from active managers into lower cost index solutions.
Investors – here and overseas - are certainly voting with their wallets as funds are flowing into index products like exchange-traded funds and out of active funds.
However, a quick reality check is needed. Even with the momentum of the past five years, indexing still only represents 18.5 per cent1 of funds under management in the Australian market.
Vanguard also offers actively managed products across both shares and fixed income asset classes in the US, and we see a role for both active and index funds within properly constructed portfolios.
The active versus index debate may not be quite as polarising as certain presidential election debates, but feelings certainly run deep when results like the SPIVA scorecard are published.
To a significant degree, active managers have made the rods for their own backs. The proposition promoted heavily to investors is that they will outperform a given index by a certain margin after fees.
So it is hardly surprising in a data-driven industry that when the numbers confirm you didn't achieve what you set out to do on behalf of your clients, some people take notice and maybe even decide to fire you and try their luck elsewhere.
The problem with the active versus index debate is that it is constantly positioned as an either/or question for investors.
The more thoughtful way for investors (and their advisers) to frame the debate is to think about how you blend both approaches to suit your risk appetite and long-term investment goals.
Vanguard refers to this as a core/satellite model, where the 'core' of an investor's portfolio is made up of low-cost index funds. Having the majority of a portfolio in these reasonably predictable and cost-effective funds provides scope to select some active 'satellite' investments, which can provide the potential for outperformance of their respective market benchmark.
When selecting active funds, there are many aspects investors can pore over, from investment style, to security selection process, to the management team's expertise.
As with any market-linked investment, time horizon is also a critical factor. We know from industry data that too often investors do not capture the full return that funds deliver – in fact, over a 10 year period, dollar-weighted returns for investors lagged their Australian managed fund performance in large cap equities by 5.2 per cent, and Australian small and mid caps by 7.9 per cent.
This is likely due to investors having sold out when funds are underperforming or buying into funds after they have had strong performance.
Having the patience to give an active fund time to perform is one thing, but judging whether it will indeed provide required performance is another.
One of the most effective indicators of future success is cost, because the less you pay a fund manager, the more of your returns you will keep. In fact, research group Morningstar has found that low cost is a superior indicator of managed fund performance.
In the context of cost, it is important to note that the SPIVA performance analysis is net of fees, meaning the cost of paying fund managers has already been factored into fund performance against their benchmarks.
Active management typically comes with higher costs – the asset-weighted average management fee for active funds in Australia is 0.93 per cent per annum, compared to 0.30 per cent per annum for index funds – which highlights the drag fees have on overall performance.
As an example, the average annualised return for active Australian equity funds over five years was 7.28 per cent, compared to 7.40 per cent for the S&P/ASX 200 index.
Now, imagine if that average annual active management fee halved.
It certainly begs the question of how much costs affect the net returns of active funds, and whether it is poor 'stock picking' skills or high management fees that are holding many active funds' performance back.
1 Rainmaker data to 30 June 2016.
Another side to personal debt
September 28, 2016 | Robin Bowerman, Vanguard Investments Australia
Certainly, rising housing prices and record-low interest rates are encouraging many families to take bigger mortgages. Yet there's another side to this headline-grabbing borrowing story.
At the same time as taking bigger mortgages, Australian households are keeping a close watch on their other personal debts. It's logical: if more is being spent on mortgages, less is left to pay credit card bills.
And another factor is at play. Economic Insights, published by CommSec, comments that personal debt has been "out of fashion" since the global financial crisis. "The post-GFC conservatism [to personal debt] is still very much in vogue."
The latest Reserve Bank statistics show that the average outstanding balance for interest-charging credit cards fell by $62.30 during July to a seven-year low of $3095.10.
In dollar terms, this decrease may seem modest. Nevertheless, it is part of a strong and extended trend of reducing average credit card debt, falling use of credit card limits and the growing popularity of debit cards.
The average use of the credit card spending limits – involving consumers "spending to the max" – fell in July to a 14-year low of 34 per cent. And the number debit cards – which involve consumers spending their own money – reached more than 43 million in July, marking the strongest annual growth in three years.
ASIC's personal finance website, MoneySmart, provides useful tips for trying to keep spending on credit cards under control. These include paying as much as possible off credit card bills each month to minimise interest and, at least, making the required minimum payment to avoid late payment fees.
Numerous disciplined credit cardholders pay off their entire bill each month to avoid any interest and cut the credit limit on their cards to minimise the temptation to overspend.
Consumers who keep their personal debts under control are putting themselves in a better position to save for retirement. Further, a critical consideration – particularly with an ageing population – is to enter retirement with ideally no outstanding mortgage debt or other personal debts.
The path of least resistance: ETFs or managed funds?
September 28, 2016 | Robin Bowerman, Vanguard Investments Australia
Building an investment portfolio for a self-managed super fund can leave some trustees feeling like explorers, trying to find the best route to an uncertain destination - the so-called place for a 'comfortable retirement' - but without the help of some basic tools like a map and compass.
With so many paths available to SMSFs, it's no wonder trustees can sometimes feel overwhelmed when trying to choose the right investments – especially at times like these when blaring news headlines about the market returns raise anxiety levels.
This was reflected in the 2016 Vanguard/Investment Trends SMSF Reports, which saw trustees saying they are finding it increasingly difficult to pick investments amid increasing volatility and less certainty on dividend yields from large-cap Australian equities.
For instance, trustees said on average that 38 per cent of their portfolios were made up of direct shares this year, down from 45 per cent in 2013.
The clear message was that trustees were finding picking individual shares more difficult – particularly when it comes to investing for higher yield – it is no surprise that SMSFs are again turning to professional fund managers in numbers not seen since the global financial crisis.
On average, 10 per cent of SMSF portfolios are now made up of investments in managed funds, up from six per cent in 2012. While managed funds have long been the go-to method of tapping professional investment expertise, exchange-traded funds (ETFs) have been gathering steam in Australia for several years.
ETFs – essentially managed funds that are listed on the share market that commonly are market cap-weighted index funds – now make up three per cent of SMSF holdings on average, with many trustees using them to gain access to overseas shares or bonds to complement their share portfolios.
So how should trustees go about deciding whether managed funds or ETFs are the best tool for their SMSF? Here are four items intrepid trustees - and indeed any investor - can use to check their bearings in the middle of the investing wilderness:
1. Strategy first, then structure
Although it can be tempting for keen investors to rush in and choose investment vehicles (or individual shares) that take their fancy, it's important for them to pause and consider their investment strategy. In particular the asset allocation that you are comfortable with from a risk perspective. Is exposure to a certain asset class or factor part of your plan? Will it give you the risk/return profile that you are aiming for?
Managed funds and ETFs have many similarities but it is important to understand the differences. Both are pooled investment vehicles, but investors may find that they will not have comparable choices in investment objectives between managed funds and ETFs. For instance, if a managed fund can provide access to a certain asset class or factor but there is no comparable ETF, then an investor's choice should be straight forward.
Above all, don't be distracted by investment products with 'all the bells and whistles'. Make sure it does what you need it to do. The aim is not to invest in the latest trend, but to gain the right exposure.
2. Is it accessible?
When it comes to ETFs and managed funds, accessibility is largely a question of how you are more comfortable getting your money in or out as needed.
For instance, managed funds will often allow investors to make regular payments by direct debit or BPAY, effectively automating the unit-buying process. For trustees making regular super contributions into their SMSF that then needs to be invested this can be an easy option.
On the other hand, ETF units are bought and sold on the ASX's exchange-traded product market. For investors who are comfortable trading shares, ETFs may be appealing because they are accessible through the same share trading platform as your direct share holdings.
Other accessibility issues that investors should be mindful of are minimum investments that some managed funds require, the fact that some investment platforms restrict access to certain managed funds.
3. How your investment is valued
ETFs and (typically) managed funds are unitised investment schemes – that is, investments can be made by purchasing units of the fund.
For ETFs, the market-price is clearly visible on the exchange. However, investors should note that buy/sell spreads for ETFs may widen at times. The more liquid the market, the more likely it is that the spread will stay closer to the underlying NAV.
Managed fund units do not have a constantly changing price through the trading day. You invest at the NAV unit price set at the close of the previous trading day. For some investors, the price certainty offered by the fund may have more appeal than the more dynamic ETF price through the trading day.
The two cost categories that investors should consider alongside headline fees are ongoing and transactional costs.
Ongoing costs are typically headline management fees, and will be the critical consideration for long-term investors. After all, the lower the investment costs, the more an investor keeps of their returns.
On the other hand, transactional costs relate to the price of buying and redeeming units. For ETFs, this is typically brokerage, which is the fee charged by a broker or platform for executing a trade.
Managed funds typically charge a small buy/sell spread, which is a cost that covers the transaction costs the fund incurs with in-flows or redemptions.
For most long-term investors, initial transactional costs will be offset by long-term gains. However, investors making regular contributions to their portfolio may find brokerage costs to be material and if an equivalent managed fund exists it will be a cheaper option.
Although using these four checks can be a useful way of picking the right tools to implement a portfolio, the most critical element of success will be the course an investor takes to get there.
Having clear goals in a written financial plan make up the essential map an investor needs to navigate the wilderness. Having that clarity of direction in place first will only make the tools you use to get there – ETFs and managed funds – all the more effective.
Taking more than you need from your nest egg?
August 19, 2016 | Robin Bowerman, Vanguard Investments Australia
A common way to measure the sustainability of retirement income is to calculate an annual withdrawal rate - the amount of income as a proportion of a retiree's total capital.
For instance, drawing an income of $4,000 a year from savings of $100,000 is, of course, a four per cent withdrawal rate.
And a leading topic of discussion in the retirement services industry is identifying an optimal drawdown rate so that a retiree's capital lasts as long as possible.
Recently-published research from Vanguard in the US goes a step further by looking how much of annual retirement drawdowns by retirees are actually spent. The findings may surprise you.
The researchers found that a high percentage of retirees receive larger withdrawals from their various retirement, investment and savings accounts (including the equivalent of our super) than needed to finance their spending over the year examined.
In turn, their findings may influence how we think further about how much to drawdown from our retirement savings each year and truly underline the importance of giving sufficient weight to retirees' actual spending habits.
The research focuses on the withdrawal and spending patterns of retiree households with a minimum of $US100,000 in financial assets. This minimum was set so participating retirees had "meaningful" financial assets to draw upon and did not rely entirely on a government age pension for an income in retirement. More than 2600 retiree households with members aged 60 to 79 took part in the survey, which was conducted in 2012 and then analysed. The retiree households had a median income of about $US69,500 (including government pensions) and median wealth in financial accounts of $US419,000.
One quarter of the retirement incomes of this sample of retirees came from their retirement, investment and savings accounts.
The researchers concentrated on 10 types of financial accounts: including personal retirement savings accounts; employer-sponsored retirement, defined-contribution plans; managed investment funds; bank accounts; and money-market accounts. (These accounts do not include, of course, guaranteed income from social security and guaranteed pensions.)
On average, the income of these households comprises: 26 per cent from financial account drawdowns, 53 per cent guaranteed income, 11 per cent wages and 10 per cent from other sources such as real estate rents and trusts.
The researchers make the point that "some or all" of compulsory minimum withdrawals from certain retirement accounts (as with pensions from Australian superannuation funds) are not always spent but reinvested in another financial account.
Key findings include:
- Three-quarters of the retiree households in the sample made withdrawals from their financial accounts. Yet only seven out of 10 households spent the money.
- A "full" 66 per cent of retiree households had spending rates of less than three per cent of their capital in these accounts (including not spending anything).
- Some 23 per cent of retiree households had a spending rate of five per cent or more of their capital. "This means that close to one-quarter of households are at risk of seriously depleting their financial assets if the observed one-year spending is sustained," the report comments.
The actual spending of retirees is obviously a critical consideration when attempting to determine how long retirement savings may last.
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