How to prepare for lower returns

The official cash rate is at a record low of one per cent and expected to go to 0.5 per cent within six months. Wages growth is negligible and we have an ageing population with more people than ever reaching retirement age with a mortgage.

Rice Warner reports that young adults today will pay 12 times Average Weekly Ordinary Time Earnings (AWOTE) to buy a home, when their parents paid no more than three times. Baby boomers have ridden a wave of strong property and superannuation growth over the past 20 years, but what lies ahead and how can retirees – and super funds – best prepare?

Rice Warner says: “We live in very strange and uncharted economic times, and the future is increasingly murky. Yet superannuation funds, admittedly distracted by incessant loads of new legislation, don’t appear to have changed their outlook in communications with members.”

Should they be telling members that they are likely to average returns of five per cent over the next decade rather than the seven per cent they have become accustomed to? Rice Warner asks.

The research house questions whether good returns have made funds complacent, pointing out that broadcast outcomes have not changed much over the years, even though economic circumstances have been very different.

Surveys show that investment experts (and indirectly the superannuation funds) are sticking to conventional forecasts of future performance and are not building on the impact of the global economic crises.

This raises two issues, Rice Warner says.

“Should funds be telling members that they are likely to average returns of five per cent over the next decade, rather than the seven per cent to which members have become accustomed?

“Should the targets be reset lower in an environment of extremely high real asset prices and a decline in world growth (and future profitability)? Should we consider whether 10 years of ‘lower-for-longer’ has expanded to permanently lower interest rates, and a different normal state?”

Rice Warner notes that the members most affected are baby boomers.

“It has been of tremendous benefit to draw the minimum pension of five per cent up to age 75 when the fund was earning seven per cent.

“Many people in their mid 70s, who have been drawing the minimum, now have more money than they had at retirement.”

With that scenario unlikely to be the case for those retiring today, funds’ communications and retirement calculators should show the impact of the potentially worse outcomes.

More members will need to draw down their capital earlier, Rice Warner warns, and super funds should prepare members for much lower nominal returns in a low interest rate and inflation environment. Funds should also educate members to promote a tolerance for higher levels of volatility if they are to have a reasonable chance of achieving adequate long-term returns.

And how should members continue to gauge whether a fund is delivering good value?

Rice Warner says that fees can be opaque and past performance cannot be relied on to estimate future returns.

“So, the best that members can do is to look at the investment objective for the MySuper strategy. Many funds have a MySuper objective equal to an annual return of CPI + X per cent per annum over rolling 10 years. X is usually 3.5 per cent to four per cent.”

Are you concerned about your super fund’s earning capacity over the next 10 years? Are you drawing down on the capital? Are you prepared to tolerate more risk?

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Written by Janelle Ward

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