How much cash should retirees hold?

Author and retired actuary John De Ravin has some strong words for retirees holding too much cash in the bank.

How much cash should retirees hold?

In recent months, the RBA has reduced the cash rate to an unprecedented historical low of .75 per cent. This reduction affects many ordinary Australians. The RBA cash rate influences the banks’ cost of funds. Therefore, the cash rate has an impact on the rates that the banks charge for mortgage loans. The cash rate also affects the interest that banks are prepared to pay depositors. So, both mortgage interest rates and the interest credited to “at call” accounts have fallen markedly. These changes raise the issue of the proportion of retirees’ financial assets that they hold as cash -  their ‘cash investment allocation’.

Deeming rates
At the same time, there has been a furore over the ‘deeming rates’ used by the Australian government for the purposes of the Age Pension income test. For the purposes of the income test, the government uses ‘deemed’ income from financial assets rather than the actual income. The ‘deemed’ rates are one per cent for the first $51,800 of financial assets (for a single pensioner) and three per cent for additional financial assets. The threshold for a couple is $86,200. Seniors groups are not happy, correctly pointing out that retirees can no longer earn three per cent on their money if they invest in ‘at call’  bank accounts or term deposits.

But the point of this article is not so much to argue the rights and wrongs of the deeming rates. Rather, I query why so many retirees want to hold a very high cash investment allocation.

Cash as an asset class
We all know that cash is the asset class that yields the lowest investment return. Any other investment (bonds, hybrids, shares, property) is likely to produce better returns than cash in the long run. Yet the fuss over deeming rates suggests that many retirees do have significant cash deposits. And I have been surprised to find, in recent discussions with half a dozen acquaintances, friends and relatives, that even some well-informed investors are holding large allocations to cash.

Valid reasons to hold cash
Let me say before proceeding that there are good reasons why you may want to hold cash. First, many financial advisers recommend (and I agree) that it is appropriate to hold some cash as an ‘emergency fund’.

The amount in your emergency fund might be between three months’ and one year’s worth of living expenses. The idea is that you have immediate access to your emergency fund if something goes wrong. For example, you may lose your job or incur a major unexpected expense. It makes sense to hold your emergency fund in cash where you have immediate access to it without any risk of decline in value. A great place for your emergency fund is in your mortgage offset account, if you have a mortgage.

Or maybe you are 88 and in failing health. You want to ensure that your care needs can be met professionally in an aged care facility of your choice. You are concerned that you will soon need to find a Refundable Accommodation Deposit (RAD). It would be reasonable to hold cash or short-term deposits up to the amount of the anticipated RAD.

But what about retirement savings?
What I’m really talking about is people who are holding large amounts of cash to fund their retirement income needs, without any short-term need for large amounts of liquidity. In this situation, it’s hard to see a strong rationale for holding much more than five to 10 per cent of your financial assets in cash. So why do people do it?

Not-so-valid reasons for holding a lot of cash
I suspect that there are many not-so-good reasons for a high cash investment allocation. Such reasons include laziness, procrastination, lack of financial literacy and excessive anxiety about the potential for market values to fall. People remember that Australian shares fell by more than 50 per cent during the GFC and think to themselves, “I can’t afford to lose half my wealth”.

But this fearful approach ignores some very important points. First, you can invest in a wide variety of ‘growth assets’, it doesn’t have to be Australian shares alone. A typical Australian superannuation fund invests in infrastructure, overseas equities, property and fixed interest securities as well as Australian shares. And when some parts of a diversified portfolio perform poorly, other components will do well. For example, government bonds will tend to do well when shares are performing poorly. Usually when ‘boom’ turns to ‘bust’ in share markets, interest rates fall, causing bond prices to rise.

What if the market falls?
Even if the market value of your investments falls significantly, that doesn’t necessarily have implications for your long-term future spending ability. After every market correction comes a recovery, sometimes very quickly. As long as you don’t need to spend much more than the investment income, it doesn’t matter much what market values do in the meantime.

Retiree investment timeframes
Even a retiree like me (I’m 63) has a potential investment timeframe of three decades. What happens to market values today, or this week, or this month, or next year, is almost irrelevant to the future flow of investment income from my portfolio for the next three decades.

Super fund performance
As a demonstration of how a diversified, growth-oriented fund can perform, I reviewed the long-term performance of the nation’s largest superannuation fund, AustralianSuper, over the last 33 years. Their ‘balanced’ investment option had a negative return in only three of those 33 years! And two of those negative returns were single digit (less than 10 per cent). True, investors in the Aussie Super Balanced fund experienced an investment return of negative 13.3 per cent in the 12 months to June 2009, in the midst of the GFC. But that was more than compensated for in the few years preceding the GFC and the few years after. Over the long term, Aussie Super (and some other well-performing super funds) have achieved between nine per cent and 10 per cent per annum average returns. You can’t get that by holding cash!

Conclusion
When you’re investing for a long period, you will almost certainly be better off in a diversified fund with a 60-80 per cent exposure to growth assets than you will be if you have a very high cash investment allocation. Earning nine per cent per annum over a long investment timeframe will produce a much better lifestyle than earning two per cent! Strategy 45 of my book Slow and Steady: 100 wealth-building strategies for all ages shows a simple way for investors with quite different risk profiles to invest and achieve much better rates of return than cash.

This article first appeared on johnderavin.com

Do you try to hold an emergency fund in the bank even though interest rates are very low?

* John De Ravin is a retired actuary whose career included work in the Australian government actuary’s office and in insurance. He has degrees in science and economics and a graduate diploma in financial planning from Finsia. He is a Fellow of the Actuaries Institute, a Fellow of Finsia and a CPA. He is the author of Slow and Steady: 100 wealth building strategies for all ages.

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    COMMENTS

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    Horace Cope
    16th Jan 2020
    10:33am
    "Do you try to hold an emergency fund in the bank even though interest rates are very low?"

    Perhaps before answering this question can we get a definition of what an "emergency fund" should cover? We are all different, and viva la difference, so each of us will have a different idea of what is acceptable to hold in cash.
    Tricky
    16th Jan 2020
    10:39am
    This still doesn't explain how the LNP government can deem income from assets not earning that amount. It's fraudulent, government is ripping off the disadvantaged pensioners and part pensioners. The government has been hypocritical on the issue of deeming rates the government condemns banks for not passing on interest rate cuts, whereby the government is hypocritical in not reducing the deeming rates as cash rate decline.
    Anonymous
    16th Jan 2020
    11:00am
    Deeming has more to do with what people earn on their investments and has nothing to do with the cash rate. If people are earning %5 then 3% is a good deeming rate. Many people would be now earning a lot more than 3% in the current investment environment.
    Horace Cope
    16th Jan 2020
    11:35am
    Tricky, the history of deeming can be traced back to its originator, Keating in 1991. Deeming rates were always below the RBA recommended rate until 2012 when Swan allowed the deeming rate to remain above the RBA recommended rate. Yes, the current government could do more but perhaps it's fair when throwing criticism, to throw it at any or all parties involved.
    Mariner
    16th Jan 2020
    11:40am
    VCBB, you have to be willing to invest your money in growth assets like shares to get the 5% and above. A lot of older people do not want to do that and only look at what term deposit bring in; at present next to nothing. So for some people cash at home might be an option as it is not deemed and of course earns nothing either.
    I like cash to pay my bills when they become due, like shortly the health insurance for 2 people, payable before end of March. Save a $100 every week and I will have the $5250 at the end of March. Same with the power bill, $20 a week will do the trick mostly. Problem might arise when I no longer can pay cash but for now it has been welcome.
    Anonymous
    16th Jan 2020
    12:32pm
    That $5250 for health insurance seems a bit high to me. I have 3 people on my policy and it's only about $4000. They have recently written to me that they have now reduced it because of my age but I haven't check to see what it is yet.
    Skiing
    16th Jan 2020
    1:30pm
    With a 15% return on super last calendar year, deeming at 3% is great. Cash for emergencies etc. at next to no return is more than offset by the growth assets.
    Mez
    24th Jan 2020
    6:17pm
    Also called DOUBLE DIPPING by the GOVERNMENT because super is already taxed at 15% and then people are SKIMMED A FURTHER 3% IN MANY CASES WITH DEEMING RATES WHICH IS MUCH MORE THAN BANK INTEREST EARNED!
    THE AUDACITY!
    Tricky
    16th Jan 2020
    12:06pm
    Horace Cope: I am discussing the now not the past. At least Keating had a vision. It was Fraser that took pension money out of the pension fund and placed it into consolidated revenue.
    Anonymous
    16th Jan 2020
    12:36pm
    There was never any money in a pension fund. it was a scam from the start when Ben Chifley wanted to increase taxes as he wanted more revenue. So he called the extra tax a welfare tax as he knew the people would accept it.
    Tricky
    16th Jan 2020
    3:16pm
    In 1966, my grandfather commented on how lucky my generation was because the federal government had a aged pension, The National Welfare fund of 1946 and by 1950 The balance in the fund was almost 100 Million Pounds and held in a trust fund with a Compulsory levy of 7.5% ,when our Politicians noted how the Aged Pension fund was accumulating Dollars all the Aged Pension fund was placed in the Consolidated Revenue Account treated as General Revenue and spent, until 1985.Noting in 1977
    Liberal Prime Minister ( Malcolm Fraser ) with Treasurer Philip Lynch ) transferred the balance in the Welfare Fund Account ( approximately $ 470.000.000 ) to Consolidated Revenue Account.
    Now Politicians point out Aged Pensioners are a drain on the government purse ,
    Actuaries have calculated the non-means tested entitlement due to each retiree, today is in excess of $ 500 per week.
    So if the greedy Politicians had left the Aged Pension fund of 1946 in place there would be no problem with Aged Pensioners drawing on the own tax paid funds.
    Horace Cope
    16th Jan 2020
    3:30pm
    The misconception around the National Welfare Fund has been aired herte before and this letter to the editor of the Bundaberg NewsMail by Keith Pitt MP clarifies the matter.


    Letter to the editor submitted to the Bundaberg NewsMail on 21 February 2017:

    Dear Editor,

    It’s unfortunate that the NewsMail has continued to perpetuate common misconceptions around the National Welfare Fund and the aged pension (NM, 16-02-17).

    I’m sure that many NewsMail readers rely on it to provide accurate information, but this is not the case in relation to this subject.

    This story caused senior citizens unnecessary angst, by including misleading details about the National Welfare Fund.

    The age pension was introduced in 1908 – several decades before Prime Minister Robert Menzies’ time – and was subject to income and assets tests.

    The National Welfare Fund was created in 1943 and included widows’ pensions, unemployment and sickness benefits, an expanded maternity allowance, and health services.

    It did not include the age pension when it was first created.

    In 1945, the Government made changes so all health and social services expenditure – including the age pension ­– was charged to the National Welfare Fund.

    At the same time the Government separated income tax into two levies – a general income tax levy and a social services contribution.

    The National Welfare Fund was not created to save up and invest workers compulsory contributions to be paid back to contributors when they retired.

    Importantly, there was never a direct link between contributions and eligibility for payment.

    An individual did not need to have paid the social services contribution to be eligible for the age pension payments and those who had paid could be denied the age pension because of the means test.

    The Menzies Government merged the social services contribution back into general income tax in 1950.

    Since that time, Australia has had no specific tax levied to pay for social security benefits.

    So, the NewsMail was incorrect to state that ‘the 7.5% levy continues to be collected as general income tax’.

    The age pension is there to help those who can’t support themselves.

    KEITH PITT MP

    Federal Member for Hinkler

    Assistant Minister for Trade, Tourism and Investment
    Anonymous
    16th Jan 2020
    3:48pm
    The National Welfare Fund was never intended to be used for welfare which includes old age pensions. It was nothing more than an increase in taxes and was introduced as a National Welfare Fund so it would be accepted as the government needed money. Since no individual accounts were set up it was consolidated revenue from day 1. Sorry folks you got conned on this one.
    Nerk
    16th Jan 2020
    12:09pm
    Your deeming pays for other pensioners, the more you declare the more you employ, the government loves you.
    old frt
    16th Jan 2020
    1:23pm
    Deeming rates only effect pensions when fin assets Over $185000 for single and $324000 for couple .If you have over this in cash deposits earning only 1-2 % , on behalf of all bank shareholders I thank you .Seriously ! Go and see a fin / adviser (I can't believe I am saying this) you are missing out on a lot of life's little luxuries . $100000 invested wisely should give you an extra $120 per week .
    Mariner
    16th Jan 2020
    3:58pm
    True - and $100'000 in the mattress will give you an extra $300 per fortnight, used to be $150 before 2017. 100x$3, some pensioners are not that daft. But how to get it out of the financial places?
    older&wiser
    16th Jan 2020
    2:14pm
    I think you are overlooking a major factor. That many seniors don't know or understand anything except cash in bank. Talk of investing, and term deposits, and shares, stock exchange, etc - are all totally unknown and big and scary. One of the major things people are told is "don't do anything with your money that you don't understand". I helped care for an elderly aunt before she moved to aged care, and getting her to use a debit card was hard enough. She will only take money out at the bank on her weekly outing. She has too little funds to be concerned about deeming rates, etc but even if she was more flush with funds, she would never do anything else with her money. And that's simply because of lack of understanding and trust in any other system.
    Anonymous
    16th Jan 2020
    3:59pm
    Next thing you will be telling us about the old lady who had plenty of money because she had lots of cheques left in her cheque book.

    Then again can't believe the number of old people who still have banking passbooks that are now nothing more than record keeping as their account is in fact electronic. Try to tell them that and they say they don't want it but they have it whether they want it or not. I set up an online account for one such person just to shown them where their money actually was and they then went and abused a bank teller. No wonder nursing homes want people to have power of attorney.
    Mariner
    16th Jan 2020
    4:05pm
    VCBB - makes me think you do not have many old people around you. If you talk to them your way they may keep even more cash in their homes. If think technology just went a bit too fast for most of them.
    Anonymous
    16th Jan 2020
    4:20pm
    I'm no spring chicken and I embrace technology. I no longer takes cheques to the bank as I can now deposit them online instead. No more trying to find the impossible park just to drop off a cheque. It actually annoys me if I have to use snail mail or I can't pay a bill online.

    It is also getting that way if I can't recognise the caller on my phone I just let it go through to message bank as if I don't I get one of the scammers.
    Farside
    16th Jan 2020
    10:50pm
    choices have consequences. If oldies are ignorant about managing their financial affairs then it is incumbent upon them or those that care about them to appoint someone (supportive attorney) suitably skilled to assist them with decisions about financial or personal matters.

    The Government offers the BeConnected program to help oldies transition and become more comfortable with technology.
    https://beconnected.esafety.gov.au/
    Ronin
    16th Jan 2020
    2:30pm
    I have significant issue with the info given in this article. It makes the error of equating past performance with future performance and fails to consider the particular risks currently. The world financial system is in uncharted waters when it comes to the amount of debt in the system, the low or negative interest rates and the highly overvalued sharemarkets compared to any logical criteria.

    Rather than return on capital, retirees should and do focus on retention of capital, losing significant capital is not an option for most retirees, as they don’t have time to ‘stay in the market’ to recoup, which may take years.

    An emergency fund that consists of physical cash, physical gold and silver, physical strong foreign currencies plus cash spread across a number of banks is my choice.
    Sceptic
    16th Jan 2020
    2:55pm
    Correct Ronin. The article ignores the fact that a retiree is no longer a contributor to Super as they are no longer earning.

    If your assets lose 50% as per the GFC, you are reliant on living on dividend income and cash reserves. The market has taken 11 years to recover the loss (ie. get back to where it was in 2008) so, unless your cash reserve including dividend income covered your expenditure over 11 years, you would have been cashing in shares. So at the end of the period, you no longer have the value of assets invested that you had in 2008.
    After calculating your annual expenditure, I would think that a retiree needs to retain at least 5 years of cash to cover the annual expenditure, the calculation of which includes income from expected dividends plus any pension payments.

    This would still leave the retiree from 2008 dipping into the investments to survive as the cash would have been gone by 2013. Each case is individual as circumstances vary person to person. But a broad brush as this article presents can do more harm than good.

    Unlike a salaried person who is still earning and contributing to super and maybe accumulating fresh investment assets, a non-salary earning retiree will never ever be able to maintain their original asset position.
    Mariner
    16th Jan 2020
    4:02pm
    Sceptic - thank you for a good explanation! Went thru the GFC and lost quite a bit, so let's hope we do not forget now in better times.
    Anonymous
    16th Jan 2020
    4:03pm
    The big problem is that we have not have had such low interest rates in our lifetimes and people can't seem to change a lifetime of thinking that cash is better than anything else. In fact cash is a terrible investment as it loses money just about every year after tax and inflation. Centrelink knows this and is doing people a favour with their deeming rates as they are getting people to invest for better returns and maintain the purchasing power of their money.
    Cheezil61
    16th Jan 2020
    5:00pm
    And who says super is safe anyways!
    Only a matter of time before Govt/pollies decide they want to get their hands on all of our super accounts & we'll all be stuffed!
    Cheezil61
    16th Jan 2020
    5:10pm
    And who even has cash or money in bank (or invested for that matter). I'm 58 & still working my a*se of to pay for day to day living expenses (have pumped everything into my mortgage most all my life until it finally went into credit a couple months ago & now playing catch up spending the $ on home maintenace that was unaffordable while every cent went to morgage) So there isn't & never was any 'spare' money for savings or investing (& I earn reasonable income doing shift work last 18yrs tho not sure what the future holds as my body/brain etc struggles big time with this physical work!)..
    Farside
    16th Jan 2020
    11:02pm
    There are plenty of people with cash and investments. It is incorrect to assume your financial circumstances are universal. Clearly you have been stretched in the past and come through to the other side but just reaching your late 50s and been in continuous employment for a long period makes you more fortunate than many. Sure some folks will be better off and good luck to them but there will also be many envious of your circumstances.
    Blossom
    16th Jan 2020
    9:12pm
    In the late 1940s - or at least in the early 1950s if you owned a car you got less pension.
    My Grandma sold hers for that reason.
    Some say about not having too much cash in the bank.
    If you own your home and things like hot water systems, water softeners and other plumbing decides to "die" and you need to replace them it is not a cheap exercise. Hot water services are often cheaper to replace than an attempt to repair, especially if its tank erupts and you end up with very hot water burning a large area of your lawn. If a water softener "spits the dummy" you end up with salty water running everywhere. That patch of lawn was doomed. They both expired within a month. The day the water softener expired we also had a problem with our car.Our fridge and deep freezer were approx. the same age. We were advised that both of them would cost so much in labour because of having to be pulled apart that it was better to replace them. They both expired within a month of each other. We had previously bought a re-conditioned fridge and it developed the same problem as the one we had before within 12 months. It was a very expensive year for replacements. We never bought things on credit cards or loans, and now I don't either. Our large rainwater tank started leaking from one small hole and a plumber was going to repair it. I'm glad he hadn't done it because 3 months later it showed quite a lot of small holes. The tank caught most of the rainwater off our house which would have gone straight onto the ground and because of the slope of our yard it would have flowed towards the back of the house. Lucky we had a good plumber who didn't charge a fortune.
    Mariner
    17th Jan 2020
    7:41am
    @Blossom - went through exactly that scenario last July, the garage was covered in water, cold water when I discovered it. Emergency cash hidden away came in very handy, costs were a shade under $2000 all up. These days it costs money to get rid of the old equipment as well (at least where we live). TV is next, still have a set top box type, the fridge/freezer is coming up to its 10th birthday. Thankfully our car is only 3 years old and probably is the last one we will need.
    Chris B T
    18th Jan 2020
    3:13pm
    Which is Safer you having Cash Stowed Away or A Financial Institution having your Cash.
    Those with short or limited Memory of Past Financial Crisis around the World, rationing of funds or no excess of funds for days/weeks and sometimes months.
    Next thing no Funds At All.
    Trust has gone and I can't Afford to be Ripped by Financial Institutions as well as GOVERNMENTS what ever the "Flavor".
    If possible at Least 1 year Expenses to 2 years, should clear any Financial Problems.
    Just to hard to replace in the Retirement Phase.
    {;-(!)
    Colours
    20th Jan 2020
    6:47pm
    The government had to be dragged kicking and screaming to reduce the deeming rate, following which the rates went down and all the benefit was lost. What they are telling pensioners is that they should be speculating on the stock market. Might as well tell them to put it through the pokies.


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