Longevity Risk in Retirement

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Despite narrative to the contrary, a significant proportion of retirees are underspending in retirement out of fear of running out of money. However, there still remains the risk of overspending and running out of funds, not being able to meet costs later in life. Both these scenarios are not ideal and they’re a key driver of why people seek financial advice in preparation and throughout their retirement.

Longevity risk is influenced mainly by three different factors: mortality risk, investment risk and expenditure. How these three factors interact through retirement generally determine whether they will have sufficient funds to see them through their later years or are forced to make do with government aged pensions, regardless of whether this is sufficient to their lifestyle needs or not.

Looking at some of these components of Longevity Risk in more detail, we start with mortality risk. Mortality risk is the chance of death in a given period of time. It can be broken down into two underlying components: Idiosyncratic mortality risk and Systematic mortality risk. Similar to the way that we think of company risk in investing, idiosyncratic risk is the specific risk that a person may die as an individual. Every individual faces the risk of death on any given day that is specific to their own personal situation regardless of how the rest of the population is faring. In the same way that any given company, depending on its specific circumstances, may be exposed to more or less risk than investment markets as a whole. For example, the risk of investing in a tobacco company are quite different to the risks of investing in a bank. So too are the risks of an individual different for a lifetime smoker compared to a vegetarian yoga instructor.

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Systematic mortality risk is your life expectancy within the overall population, and it tends to be the greater focus in financial planning when trying to make judgements around longevity. Life expectancy of the whole population changes over time; with advancements in medical technology and a greater understanding of the impact of lifestyle; things like diet and exercise, mental activity, etc. are reflected in continuously changing life expectancies. It manifests in facts like that someone at the age of sixty-five today can expect, based on population trends, to live much longer than just ten or twenty years ago. So, when trying to estimate how long people will live for in retirement, we need to not just take into consideration current life expectancies of populations, but potentially over shooting from advancements in life expectancy as we move into the future.

This can be further complicated when trying to plan for retirement with things like the male/female life expectancy differential, though this difference has been narrowing over time to now being within just a couple of years for individuals at aged sixty-five. But probability still states that roughly one individual in every two couples, is likely to live to age one hundred, despite individual life expectancy only somewhere in the mid to late eighties.

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Our next major factor in Longevity Risk, as it relates to retirement planning, is investment risk. However here we are primarily concerned with sequencing of returns, in addition to the actual long-term investment return, as the sequence of future returns, particularly in the early part of retirement, is critical to how long our funds last. The basic premise is that the order of returns that you experience (strong returns or weak returns early on, positive returns up front, or negative) in your retirement years can be more important to the overall result of whether your or not your funds last for your retirement than the actual average rate of return over say a given thirty year period. 

An average return of just six or seven percent can be more than ample for requirements where the first ten years of investing are largely positive, as opposed to the dramatic impact where, with the same thirty -year average return, we experience a high frequency of negative or poor returns in the first ten years.

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Under both these scenarios, the long-term, average return can be the same, but the sequence of a poorer first ten years of returns can have a dramatic impact when funding retirement through regular systematic withdrawals from your investment base. Dynamic Asset Allocation can help manage this particular risk, but it can also be impacted and managed somewhat through the use of a Dynamic Expenditure plan, which brings us to the last component of the Longevity Risk; Expenditure.

Expenditure in retirement is not simply a reflection of available funds but can be impacted also from likely lifestyle requirement of retirees. In the past, Safe Withdrawal Rates popularized by William Bengen1 where a withdrawal or expenditure rate generally of four percent (of your retirement savings) has been considered to be a safe maximum. New research, in particular that from the New Zealand Commission for Financial Capability, considers that there are actually three different stages in retirement with different expenditure requirements; an Active, then Passive, then Supported phase.2

The Active stage is the early years of retirement, approximately the first decade, when lifestyle is the main driver of spending, as retirees have the energy and desire to be active. This can reflect itself in additional expenditure on things like travel, hobbies and other types of active endeavors. The following decade can be categorized as more Passive, where there is generally less appetite for activity and spending can commensurately drop. Then for those find themselves in the later stage of retirement; roughly eighty-five plus years of age; support increasingly is required with higher medical and health care costs and potentially aged care needs. Marking an increase again in expenditure needs.

Source: Commission For Financial Capability

Source: Commission For Financial Capability

Consequently, the interacting requirements in Financial Planning for Longevity Risk in Retirement necessitate an ongoing adaptive approach to plans, where the interaction of life expectancy, investment markets, expected returns and sequencing of returns as well as the changing needs of retirees depending on their stage of retirement, can result in the need for continuous adaptation of an investment strategy.

Other influences that can complicate Longevity Risk in Retirement Planning can be retiree’s desire to leave (or not) a substantial estate to surviving children and whether or the not the spending down of financial capital is allowable part of the strategy (i.e. spending the kids’ inheritance). Does a principal residence form part of accessible funds for the retirement strategy, specifically in later years such as funding aged care needs? The continuing play of these risks, and how we prepare for them, form the basis of Longevity Risk and Retirement Planning for financial planning clients.

1. Bengen W 1994, Determining withdrawal rates using historical data, <http://www.retailinvestor.org/pdf/Bengen1.pdf>

2. Commission for Financial Capability , n.d., The three stages of retirement, Commission for Financial capability, Auckland, viewed 30 January 2018 from <https://www.cffc.org.nz/retirement/thethree-stages-of-retirement/>

Investing to achieve your goals

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How are your New Year’s resolutions progressing? Many of us start out with the best of intentions – to get fit, improve our diet, drink less, travel more, get out of debt or get ahead financially. But without clear goals and a plan to achieve them, our good intentions are likely to remain just that.

The good news is that it’s not too late to turn your New Year’s wish list into achievable goals. You give yourself the best chance of kicking goals if you focus on the process and break your long-term objectives into a series of steps.

Most meaningful goals require a change in behaviour that can’t be achieved overnight. If you’re a couch potato who dreams of running a half marathon, you need to learn to walk before you run. To develop the exercise habit, you may need to rise an hour earlier each day and team up with a buddy to encourage you to keep going. You may also need expert advice to create a detailed, personalised exercise plan and help measure your progress.

 

Goal-based investing

Financial goals require a similar approach. Take the long-term goal of saving for retirement. The traditional approach is to simply save as much as possible between now and then, with a focus on maximising investment returns after assessing your risk tolerance. Depending on your risk profile your money would be invested in an aggressive or defensive portfolio.

By comparison, a goal-based approach to investing aims to align your investments with your personal objectives. By asking where you want to be in 5, 10 or 20 years you can work out how much you need to save to achieve your goals and create savings habits to help you get there.

Rather than simply saving for retirement, you might aim to retire at 55 with enough money to live comfortably with regular overseas travel. To fund this lifestyle, you decide you need to generate income of $5000 a month for up to 40 years, bearing in mind that more of us will be living into our 90's.

Then you can begin to join the dots. Given your current age and income, you can work out how much you need to save each month and how much risk you need to take to reach your goal. If the risk required is out of your comfort zone, or your goal is financially out of reach, it’s time to adjust your plans. You could delay retirement, look for savings in your budget or modify your aspirations.

 

Measuring success

The typical approach to investing uses investment returns aligned to your risk profile to measure success. If you beat the relevant market benchmark you’re doing well. But it’s not much consolation to know you beat the ASX 200 index by 2 per cent if the market was down 20 per cent. It’s also not conducive to sleeping at night.

Success in goal-based investing is about being on track to fund your goals. You still need to monitor returns, but if you decide you want $60,000 a year in retirement, success is saving enough to get you there.

In practice, most of us have multiple goals that require extensive planning. You may want to buy a home, save for the kids’ education or an overseas holiday adventure as well as saving for retirement. Each goal has a different time horizon, which may call for a different investment strategy.

Generally speaking, you can afford to be less conservative with long-term goals because time is on your side. But if you’re saving to buy a home in two years’ time, your money needs to be accessible and not at risk of short-term market volatility.

The start of a new year is a great time to think about what you would like to achieve in the year ahead and beyond. If you would like some help with strategies to turn your resolutions into reality, give us a call.

2017 Year in Review: Fair winds guide investment returns

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Investors had plenty to smile about in 2017, despite a world of worries on the geopolitical stage from the Middle East to North Korea and the South China Sea. The global economy continued its steady improvement and financial markets produced some excellent returns. 

The year began with the inauguration of President Donald Trump, whose populist policies on issues such as trade and energy have impacted the global economic agenda. As the year closed the Trump administration’s corporate tax cuts were approved by Congress, which should boost US economic activity. 

The US Federal Reserve lifted its benchmark interest rate three times in 2017, with more expected this year as the economy strengthens. 
 

Positive economic growth

The global economy grew steadily throughout 2017 with the US and other G7 leading industrial nations growing at around 2.2 per cent. China’s growth has slowed, but at 6.8 per cent it’s still a global powerhouse and a major customer for Australia’s natural resources, education and other goods and services.i

Australia’s economy grew by 2.8 per cent in the year to September, marking 26 years without a recession. The biggest contributor was private sector investment as business profits posted their strongest gains in 15 years. 

Unemployment fell to 5.4 per cent, but sluggish wage growth remains an issue for the Reserve Bank.ii A jump in consumer confidence to 103.3 on the Westpac Melbourne Institute scale – anything above 100 is viewed as optimism – was good news for retailers leading into Christmas.iii
 

Mixed signals on financial markets

The Australian dollar finished the year at US78c, up 8.6 per cent, due mostly to strong commodity prices. The cash rate held steady at 1.5 per cent all year while interest rates on government 10-year bonds fell from 2.77 per cent to 2.64 per cent.iv The consensus is that the next interest rate move will be up although perhaps not until later this year. 

Commodities were a mixed bag. Global oil prices rose 12.5 per cent to US$60 a barrel as OPEC members agreed to extend production restrictions. Iron ore fell 3.3 per cent on lower demand from China, while coal rose 5.7 per cent.v

The shooting star award of 2017 goes to Bitcoin. The value of one Bitcoin soared from around $1300 in January to a high of over $22,000 before dropping to around $17,000 at year’s end. 
 

Shares surprise on the upside

Global shares powered ahead, fuelled by economic growth, strong corporate profits and low interest rates. 

US shares rose to record highs, up 19 per cent partly in response to the weak US dollar. The low dollar and Brexit uncertainty were a drag on the UK market, but it still managed a 7 per cent lift. Eurozone leaders Germany and France posted gains of 12 per cent and 9 per cent respectively. Asian and emerging market shares were also among the top performers, with the Japanese market up 19 per cent.vi

 

Property cools

Australian home prices rose 4.2 per cent last year compared with 5.8 per cent in 2016, dragged down by the cooling Sydney market which was up just 3.1 per cent. Hobart (up 12.3 per cent) and Melbourne (up 8.9 per cent) were the strongest capital city markets, followed by Canberra (4.9 per cent), Adelaide (3.0 per cent) and Brisbane (2.4 per cent). Darwin fell 6.5 per cent and Perth was down 2.3 per cent.vii

Most observers predict subdued growth rather than a market bust in the year ahead. 

 

Looking ahead

There is every reason for cautious optimism in the year ahead, although there are risks too. Continuing investigations into Donald Trump could destabilise his leadership and global markets, while closer to home the Reserve Bank is keeping a watchful eye on wages, inflation, the Aussie dollar and property prices. 

Even so, local economic growth is on track, interest rates are likely to remain low for some time yet and first home buyers have their best chance in years to get a toehold in the market. Australian shares look fair value although global equities are likely to continue to provide higher returns. 

i Trading economics, https://tradingeconomics.com/country-list/gdp-annual-growth-rate?continent=america
ii Reserve Bank of Australia, http://www.rba.gov.au/snapshots/economy-indicators-snapshot/ 
iii Westpac Melbourne Institute Consumer Confidence, 13 December 2017, https://www.westpac.com.au/content/dam/public/wbc/documents/pdf/aw/economics-research/er20171213BullConsumerSentiment.pdf
iv RBA, rba.gov.au
v Trading economics, https://tradingeconomics.com/commodities
vi Trading economics, https://tradingeconomics.com/stocks
vii CoreLogic, 2 January 2018, https://www.corelogic.com.au/news/national-dwelling-values-fall-03-december-setting-scene-softer-housing-conditions-2018#.WlKzW1WWZhE

Opportunities in the cooling property market

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Things are looking up for first home buyers for the first time in years as house price growth begins to slow across the country. While prices have been on the slide for some areas in the West and the North since the end of the mining boom, the housing market in Sydney and Melbourne also appears to be losing steam. 

At a national level, house prices were unchanged in October and up just 0.3 per cent over the quarter according to the latest figures from property research group CoreLogic. Significantly, the over-heated Sydney market fell 0.6 per cent over the three months to October, joining Perth and Darwin which have been falling since 2014.i

Hobart is the top performing market, fuelled by mainlanders searching for more affordable housing. Prices for Hobart dwellings rose 12.7 per cent over the past year, although price growth slowed to 0.09 per cent in October. It’s easy to see why people are flocking to the Apple Isle; the median dwelling value of $396,393 in Hobart is less than half what you can expect to pay in Sydney ($905,917) where prices are up 74 per cent since the boom began in early 2012. 

Melbourne is the second most expensive city, with an average dwelling price of $710,420. And while the Melbourne market isn’t falling, it also shows signs of cooling with growth of 1.9 per cent in the three months to October and annual growth of 11 per cent. Other capital cities show little change with Brisbane up 0.6 per cent over the quarter while prices in Adelaide rose just 0.1 per cent. 
 

Tighter lending begins to bite

The Australian housing market is a tale of many markets, each with their own supply and demand issues. But there are some common factors at play. At a national level, concerns about rapidly rising prices, risky lending practices and worsening housing affordability prompted regulators to act. 

In late 2014, the Australian Prudential Regulatory Authority (APRA) announced that lenders were to limit housing finance to investors to 10 per cent of their total home lending. Then in March 2017 APRA announced a 30 per cent limit on new, interest-only home loans to dampen risks in the housing market. 

In April the Australian Securities and Investments Commission (ASIC) signalled a crackdown on lenders and mortgage brokers recommending more expensive, interest-only loans to customers who were often unaware of the risks. 
 

Investors paying more for credit

Lenders responded to the regulators’ concerns by lifting interest rates on interest-only and investor loans. According to comparison site Canstar, the average standard variable rate for investors has grown to around 0.5 per cent higher than the equivalent rate for owner occupiers. 

And it seems these measures are working. The number of investor home loan approvals dropped sharply in 2015 and again in 2017, while owner occupier loans have shown a significant uptick in 2017.ii

While tighter lending policies have undoubtedly taken some of the heat out of the housing market, other forces may also be playing a role. 
 

Understanding supply and demand

So far there is little sign of a housing bust in Australia, with significant unmet demand from first home buyers, high levels of migration and land shortages in major urban areas. But when house prices rise as far and as fast as they have in markets like Sydney and Melbourne, it’s natural to expect periodic corrections. 

Commentators have been warning of an oversupply of apartments in Melbourne as well as in Brisbane. The Brisbane market has been cooling for some time, and now property values in Melbourne are rising at their slowest quarterly pace since 2016. 

Despite the slowdown in price growth, Australian housing is still far from cheap. But with tighter controls on investor lending and continuing low interest rates for owner occupiers, the tables may be finally turning in favour of first home buyers. 

 All price data from CoreLogic, 1 November 2017, https://www.corelogic.com.au/news/growth-conditions-remain-flat-national-basis-while-sydney-values-fall#.WgEZ3uQUnIU

ii ABS; RBA

Separating needs from wants

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Even those of us who have been paragons of responsibility for 51 weeks of the year can be tempted to take a budgeting holiday when Christmas and the summer vacation roll around. Unlike overindulging at the Christmas lunch, this has more than short-term consequences. 

Last December, Australians spent $25.6 billion in retail stores. A survey conducted at the time by peer-to-peer lender SocietyOne found shoppers planned to put over half the cost of the presents they bought on credit or store cards. SocietyOne’s research also found that while shoppers believed they’d pay off their festive splurge by April, most actually wouldn’t. 

If you don’t want to stagger into the New Year with a painful debt hangover, it’s worth taking a moment to sort your needs from your wants. Separating wants from needs can be one of the toughest aspects of budgeting, particularly around the festive season. 
 

Needs are not the same as wants

The line between needs and wants can be a little blurry but a good rule is to ask yourself ‘Do I absolutely need to have this?’ If the answer is no you’ve probably identified a want. 

You may want to serve French Champagne at your Christmas lunch but you don’t need to. Nobody’s suggesting you shouldn’t splash out at this special time of year. But your lunch guests are likely to be more than satisfied with a sparkling wine. You don’t need to spend money you don’t have on extravagant gifts and entertaining to express your love for, or try to impress, friends and family. 
 

This is no time to take a budgeting holiday

Your wants are very much driven by emotion. We all want to shower the people we love with gifts, an abundance of festive food and other treats. However this can lead to impulse spending we did not originally plan for. Focus on the essentials and plan how much you’re going to spend before you head to the shopping mall then stick to that budget once you get there. 
 

Avoid buying now, paying much more later

Just because you want something but don’t need it doesn’t mean you shouldn’t buy it. Make sure you’ve got enough to cover your needs or basic day to day expenses, then with what’s left over, prioritise your wants. 

It’s also important to consider how you are paying for the little luxuries. Watch out for the temptation to put them on credit. The average credit card balance is $3,130 with interest being paid on $1936 of that amount. The amount of interest varies, but at a time when interest rates are at unprecedented lows, Australian credit card users typically pay 10-15 per cent interest. The interest rate for most store cards hovers around 20 per cent. 

Credit cards are not even necessarily the most expensive form of retail debt. If you enter into one of those ‘pay nothing for 6, 12, 18 or 36 months’ deals you’ll be looking at an interest rate of almost 30 per cent once the interest-free period ends. 

A more recent market entrant called Afterpay – a type of reverse layby where you get the product now and pay it off afterward – has rapidly gained traction in Australia. A big part of Afterpay’s appeal is that no interest is charged on the amount owed. But fees are levied if repayments aren’t made so it’s possible to end up paying $68 in fees on a $100 purchase. 
 

Avoiding debt

The simplest way to avoid pricey debt is to avoid spending money you don’t have. Wherever possible, limit yourself to using lay-by, cash or a debit card to cover Christmas expenses. 

With a bit of planning you can manage to take care of your day to day needs and still afford some luxuries of the festive season – without copping the credit card hangover in January. 

Future Fund: 5 megatrends are changing everything

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It’s always useful to study the asset allocation of Australia’s sovereign wealth fund, the Future Fund, as it takes an unusual approach to investing. Whereas most institutional superannuation funds hold at least 25% of their assets in Australian equities, the Future Fund’s allocation at 30 September 2017 included only 6% to Australian equities. The main categories where it is overweight versus the industry are private equity at 12% and alternative assets at 15%. Cash is a healthy 19%. That’s nearly half its $134 billion in assets in these three categories, two of which barely move the needle for most SMSFs.

The main reason for this structure is the desire to protect capital. Its investment mandate is to achieve CPI plus 4% to 5% “with an acceptable but not excessive level of risk”. In its investment beliefs, it shows why assets such as private equity and alternatives figure highly:

“Markets can be inefficient, albeit that the degree of inefficiency varies across markets and over time. Skillful management can add value after fees, and such added value can be uncorrelated to market returns over time and can therefore be highly beneficial to the total portfolio investment characteristics. Capturing skill-based returns requires an appropriately resourced and disciplined process.” (my bolding)

Their beliefs drive them towards long term, illiquid and uncorrelated assets to extract returns for risk.

Five insights from the 2017 Sohn Conference

The Future Fund’s Chief Investment Officer, Dr Raphael Arndt, spoke at the recent Sohn Hearts and Minds Investment Leaders Conference. He identified five megatrends changing the world of investing:

  1. The end of the leverage tailwind means asset prices are not supported by as much debt, making price growth less sustainable.
  1. Declining population growth will reduce economic growth, with the United Nations forecasting global population growth will fall from the current level of around 1.5% to 0.25% by the turn of the century.
  1. Changes in the workforce and consumer preferences mean the best future investments will differ from the past, because younger generations consume and work differently. He included this chart showing that by 2025, baby boomers will comprise only 8% of the Australian workforce, while both millennials (Gen Y) and Gen Z (roughly, those born after 2000) will each be about one-third.

Changes in the Australian workforce, today and 2025

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Source: Future Fund, Mark McCrindle

  1. Income inequality is increasing populism and populist policies, with many people in developed countries receiving little growth in wages in the last 20 years. The rich have become richer through asset price growth but populist policies will reduce economic growth.
  1. Technology is changing how society interacts, with new platforms achieving adoption faster than at any time in history.

Investments can become worthless quickly in the face of disruption by new technologies or competitors, and the past should not be taken as a guide to the future. This is one reason why the Future Fund holds so much cash. He emphasised the Fund’s desire to find returns which are uncorrelated to the equity markets and companies adversely hit by these trends, which explains the alternatives (or hedge fund) allocation.

Over the last seven years, the 9.9% return delivered by the Future Fund comfortably exceeds the CPI+ target of 6.5%.

 

Graham Hand is Managing Editor of Cuffelinks.

original article available here: https://cuffelinks.com.au/future-fund-megatrends-changing/

Gearing up for growth

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Record low interest rates are making it harder for your money to keep pace with the rate of inflation. While it may be a struggle to grow your wealth in such an environment, low interest rates do mean that it is cheaper to borrow. 

So why not take advantage of this opportunity by borrowing money to invest in growth assets such as shares or property? Gearing (borrowing) can be a great way to fast-track wealth creation although it must be remembered that it is a double-edged sword. While using borrowed money magnifies profits, it also magnifies losses. However, by borrowing sensibly and cautiously, and investing in quality assets, the benefits can outweigh the risks. 

As well as boosting your returns, there are also tax advantages because you can offset interest paid on your loan against your income. 

What are your options?

There are a number of ways you can borrow to invest including home equity loans, margin lending, warrants and internally geared managed funds. Each has its pros and cons so it is wise to get professional advice. 
 

Home equity loans

As the name implies, home equity loans let you borrow against the equity you have built up in your home by using a redraw facility or an additional line of credit. 

This method of borrowing is relatively cheap to service as you are only paying mortgage rates of interest. The downside is that you put up your home as collateral. 
 

Margin loans

The second method is via a margin loan where you typically borrow somewhere between 30 to 50 per cent of the value of an asset. The lender will stipulate the maximum you can borrow, called the loan to value ratio (LVR). 

If markets fall, your LVR will rise and if it rises above a certain level you have to pay extra money to rebalance your borrowing. This is called a margin call and may be requested at short notice, forcing you to sell some of the investment quickly (and at a bad time) to meet the call. 
 

Warrants add leverage

Warrants, which are traded on the Australian Securities Exchange, give you exposure to an underlying asset for a portion of the price without the need for margin calls. 

As a result, a warrant gives you leverage which means small changes in the value of the underlying asset result in larger changes in the value of the warrant. This magnifies gains and losses. 

There are many types of warrants, each offering a different level of risk and leverage. Warrants can be on individual shares or on exchange traded funds which offer greater diversification. 

The maximum you can lose is the amount you paid for the warrant. As the borrowing is non-recourse, you can walk away and only be liable for the loan. 

Gearing made simple

The simplest alternative is to let a professional handle the borrowing for you with an internally-geared managed fund. The advantage here is that you don’t need to take out a loan yourself, risk your home as collateral or face a margin call. 

Such funds are for investors seeking capital growth rather than income and should be viewed as a long-term investment as the funds are generally more volatile than the sharemarket in the short term. 

You can also gear up your selfmanaged super fund with a limited recourse loan. The rules are complex so it is vital that you receive the right advice to make sure you comply with superannuation laws. 

By adopting a borrowing strategy that aligns with your risk profile, you can turn today’s low interest rates into tomorrow’s gains.

Homing in on a happy retirement

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Owning your own home has long been the Australian dream but after years of strong house price growth it’s becoming less of a reality for many. This has major implications for retirement planning. 

The major factor behind the shifting approach to home ownership is the prohibitive price of property, particularly in Sydney and Melbourne. As a result, today’s younger generations may be close to 40 before they take their first step on the property ladder. 

It’s sometimes argued that renting can be just as wise as owning. Advocates say you can invest the money you save through not paying rates, meeting the costs of maintenance or interest on loans. But this strategy can prove a problem in retirement. 

Owning your own home is often viewed as the fourth pillar of our retirement support system, with the other three being superannuation, savings and the aged pension. 

 

Increase in mortgage debt

In the past, it was assumed that most people will own their own home outright and be mortgage free by the time they retire. Accordingly, the burden of paying rent or loan repayments is generally not taken into consideration in assessing the cost of living in retirement. 

But in recent years there has been an increase in the numbers of retirees holding mortgage debt. In fact, 9.7 per cent of people aged over 65 had mortgage debt in 2013-14 compared with just 3.9 per cent in 1995-96.i

More significantly, the number of people aged 55-64 with an outstanding mortgage debt had jumped 29 per cent from the level in 1995-96 to 44.5 per cent in 2013-14.i It’s safe to assume that many people in this age group will still be in debt once they reach retirement. 

Some of this increase in mortgage debt can be put down to the rising cost of housing. An additional factor is the increasing divorce rate which means people can find themselves in the uncomfortable position of starting anew in the housing market later in life. 

 

Cost of housing

If you choose the rental path, you could struggle in retirement as rent can take up an increasing amount of your available income. 

In the past, well over half of renting retirees were in public housing, but that figure has dropped to less than 40 per cent due to reduced availability of public housing.(i) This has implications for retirement incomes. 

Today, tenants aged 65 or over renting from private landlords spend 35 per cent of their income on housing costs.(i) Anything more than 30 per cent is regarded as being in ‘housing stress’. 

Looking at housing figures overall, including those who rent as well as own, 22 per cent of all retirees spent more than 25 per cent of their income on housing in 2013-14, this number has been steadily rising over time.(i)

 

Advantages of home ownership

One of the advantages of owning your own home outright in retirement is that you can always draw on the capital if necessary either by way of a reverse mortgage or taking out a loan using your home as collateral. 

Another plus is that you have an asset to pass on to the next generation. Although for many baby boomers, passing on wealth is no longer a key focus. In fact, many prefer to use some of their savings to help their children get a foothold in the housing market. 

A COTA50+ survey found that around 40 per cent of self-funded retirees have helped their children or grandchildren fund a deposit for a home.(ii) 

For those who have the funds, this can be a good strategy. However, you do need to be mindful of leaving yourself short in retirement by passing on too much of your money too early. And if you are already retired and receiving an aged pension, then you will be limited to gifting your children no more than $30,000 over a rolling five-year period. 

Housing affordability is becoming an issue for Australians at both ends of the age spectrum. That’s why it’s a good idea to have a talk with us to discuss your retirement housing and income needs. 

i ‘No place like home’, prepared by Saul Eslake for AIST, March 2017, http://www.aist.asn.au/media/20734/AIST_Housing%20affordability%20and%20retirement%20incomes_FINAL%2021032017.pdf
ii https://www.cotansw.com.au/MediaPDFs/COTA%20NSW%2050plus_Report_2016web.pdf

 

Lessons from the GFC - 10 years on

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It’s been a decade since the market crash known as the Global Financial Crisis rocked the investment world. At the time investors could only watch in disbelief as 50 per cent was wiped off the value of their shares. Arguably, the actions those investors took are still reverberating today. Which begs the question: what are the key lessons of the GFC and did we pay attention? 

Predictably, there were warning signs before the eventual market crash. Just as predictably, no-one could predict the exact timing or the magnitude of the crash. 
 

What happened?

Ground zero of the GFC was in middle America. A lengthy period of low interest rates and poor home lending practices left homeowners vulnerable when rates began to rise and house prices fell below the amount they owed the banks. When whole neighbourhoods walked away from their homes and their debts, the liability shifted to the banks. 

Compounding the housing bust was the proliferation of new financial products that packaged up sub-prime loans along with higher quality debt and sold them on to global investors. These derivative products with names like collateralised debt obligations (CDOs) were sold as cutting edge but few investors understood the risks. 

When in 2007 investors tried to dump their CDOs the investment banks that issued them were unable to finance redemptions. The crisis led to a credit crunch and the eventual collapse of major investment firms like Bear Stearns and Lehmann Bros. 

The shock impacted markets around the globe. The Australian sharemarket followed Wall Street, falling around 50 per cent from its peak in November 2007 until it hit rock bottom in March 2009. 

What lessons did we learn?

Ten years is a long time on global markets. The US sharemarket is experiencing its second-longest bull run in history – eight years and still going strong. Australian shares have also had eight good years, although prices are still below the 2007 peak. All of which makes this a good time to ask if investors still remember the lessons of the GFC. Judging by a recent investor survey by Deloitte Access Economics for the ASX, it could be time for a refresher. (i)

Overall, 21 per cent of investors said they had little tolerance for risk but still expect annual returns of 10 per cent plus. Worryingly, less than half have diversified portfolios. But the real surprise was that older investors who lived through the GFC were less risk averse than younger investors who have no direct experience of a market crash. 

 

Be aware of market cycles

Perhaps older investors have learned what goes down comes back up, albeit with some twists and turns along the way. Time in the market also makes investors aware that one year’s best performing asset class can be next year’s worst. The best way to avoid timing the market is to have a diversified portfolio and ride out the short-term volatility. 

These lessons were borne out recently when Vanguard looked at the outcome for three investors with a diversified investment portfolio of 50 per cent shares and 50 per cent bonds when the GFC hit.(ii) When the market bottomed in March 2009 one sold the lot and switched to cash. One sold all their shares and put the money into bonds. And one stayed put in a balanced portfolio. 

Fast forward to 2016 and the investor who fled to cash was sitting on a cumulative return of 27 per cent. The investor who put everything in bonds had a return of 71 per cent. But the investor who sat tight with a mix of shares and bonds enjoyed the best return of 93 per cent. 

While each boom and bust cycle is slightly different, investors who understand the trade-off between risk and return, hold a diversified portfolio and stay the course are best placed to ride out market cycles for long-term success. 

i ASX Australian Investor Study 2017 by Deloitte Access Economics 
ii ‘Lessons from the GFC 10 years on’ by Robin Bowerman, 4 October 2017