Sequencing risk - What can retirees do to minimise it?

Sequencing risk is the risk that you experience negative returns early in your retirement.  Because you are drawing on your capital, the sequence of returns matter even if the long term returns work out to be the same.

It is a really difficult risk as we don't know what order of returns you will get. Over the long term, we can be pretty confident on the returns a portfolio will deliver within a couple %, but over the next 12 months, they can be very varying.

Retirees who went through the GFC were told to not panic, markets come back etc etc. and those who stayed invested are definitely better off than those who switched to cash at or near the bottom of the market. But the fact you have been drawing on your money, means it won't bounce all the way back as you might be expecting and it is an issue.

So, how serious is sequencing risk? Let's relate it to Russian roulette. The chances of getting the bullet is pretty small (1 in 6 I think, not too familiar with guns), and once it goes click - no bullet, you're fine. What was the issue? But, there is that 1 in 6 where it becomes a serious issue. So, what can we do to keep you alive if you are that 1 in 6 (I'm not saying there is a 1 in 6 chance of a major negative return for retirees, I'm just keeping with the Russian roulette odds).

Have a look at the following graph. It shows 2 retirees with the exact same portfolio and returns. One uses the returns from January 1990 through to end of Feb 2009 (bottom of the GFC), and the second person is reversed. ie. they got the bad returns of the GFC first up. This is for a retiree with $500,000 and drawing $30,000 per annum increasing at 3% p.a. On paper, these 2 people had the exact same annualised return for almost 20 years but in reality, have a very different outcome. If they had retired at age 60, they would be 80 now and with possibly another 10 - 20 years left in retirement - you wouldn't want to have just $264,500 remaining and drawing over $50,000 per annum (as that what it now would be after inflation for 20 years). It isn't going to last long, even if you get better than average returns over the next few years.

So, what can you do to avoid this/limit the risk? Well, there is a few things you can do. One would be to return to work for a couple more years if you were to experience bad returns first up, however, for a person who retirees just prior to a GFC type situation, it can be very difficult. They are unlikely to be able to re-enter the workforce due to their age and unemployment has possibly just increased.

So, better planning and going into retirement with a greater asset base. This first example started drawing 6% of their asset base, increasing with inflation. Although that looks fine in the scenario with returns from 1990 going forward, that was a particularly good time through the 90's and 00's. Having a greater asset base at retirement and drawing a smaller proportion reduces the issues around sequencing risk.  The following graph shows the same 2 sets of returns, same annual income, but they start off with $1,000,000 rather than $500,000. As you can see, the negative returns early had less of an impact on their overall retirement.

Another option is to reduce the amount you are drawing as soon as you start having poor returns for a while to reduce the negative impact of the downturn. The following graph shows the 2 scenarios from the original example, but a 3rd scenario of reducing the annual draw down to $12,000, after the first 2 months of negative returns, increasing with inflation for 3 years, then reverting to the original draw down.

Another thing you can do is to have a more conservative asset allocation. With a lower allocation to growth assets, sequencing risk becomes a smaller problem. But, that then opens up to a greater risk of outliving your money because you didn't achieve high enough returns though out retirement. Alternatively, if you are faced with poor returns early, you could take an aggressive approach to get out of the situation, by increasing your allocation to growth assets during the down turn (this approach would work well when combined with reducing your draw downs as well), but again, it isn't a free lunch because you are increasing the risk of your portfolio.

What about those people who retired in 2006,07,08. They are now quite a few years on and can now see that they are faced with a lack of capital for a potentially long retirement. What can they do?

Well, there is no magic bullet. You could reduce what you are drawing (almost indefinitely) to allow your portfolio life to extend as long as possible. Take a more aggressive investment allocation but that comes with increased risk. But ideally, return to work, even in a part time role just to supplement your income to minimise the draw down on your portfolio so it can recover.

At any point in time, getting good quality advice will be the best way for you to navigate your entire retirement financing issues.

If you would like advice on your retirement planning, contact Glenn Hilber on 1300 200 012 or enquiries@precisionwm.com.au. Or visit the Precision Wealth Management website at www.precisionwm.com.au

Annuities - Are they really good?

I was watching TV the other night and they had an ad for annuities. Annuities provide a guaranteed income for a defined period of time, some of which are for your lifetime, however long that may be. I must admit, the ad looked quite good and I imagine would work quite well for someone approaching retirement who might be a bit worried about investing in the stock market or for whatever reason really likes this idea of "security".

But how good are they?

Well, I thought I would have a look into it and do some calculations for a comparison.

Right now, you can get an annuity (for a 65 year old male) that will pay $4,268.77 per annum for the rest of your life guaranteed. I stress to clients or prospective clients that longevity is a big risk for retirees, we are living so long in retirement that you need to be prepared. So the idea of an income stream that could potentially last for 30+ years sounds pretty good, right?

Well, maybe not so. Lets assume our 65 year old male purchases his lifetime annuity for $100,000 and gets his $4,268.77 and he lives quite a good life and lives to 100 years old, so he receives his annuity payments for 35 years. His original capital investment of $100,000 has returned $149,406.95 in annuity payments, so it's really only earned him $49,406.95 as the lifetime annuity in this example has no residual value if death is after the first 15 years.

So, lets take another person who decides to invest it in a reasonably conservative, diversified portfolio which can expect to earn 6% per annum with growth and dividends/interest. This person also takes $4,268.77 per annum from his investment until he reaches 100 years of age. He has also taken his $149,406.95 in payments over the 35 years, but the original investment still remains and with the growth after all his payments, has a residual value of $264,378.

So the annuity person received $149,406.95 and the person who invested and achieved 6% per annum has a total of $413,784.95 (the income they've taken plus the remaining capital value).  Or to look at the annuity another way, a $100,000 investment, drawn down to $0 after 35 years with an annual payment of $4,268.77 works out to an equivalent interest rate of 2.42%. Do you really want to lock yourself into an investment which is going to give you an equivalent rate of 2.42% over 35 years?

If you are still thinking "ohhh...but with the global financial crisis I just don't know, I might not get a very good return anywhere else", the example I gave was a 6% return. My model portfolio with 50% growth assets and 50% defensive assets has returned 7.08% over the last 10 years - The GFC was right in the middle of that.

Do you want to take a very very small chance that you might not achieve the investment return you wanted over 35 years? Or do you want to guarantee the investment return over 35 years is not very good (ie. the annuity).

In fairness to annuities, they can provide Centrelink benefits with favourable income and asset assessment so there can be a benefit there.

We just can't go without

Can you imagine always leaving home without a mobile phone. The moment you leave the house, you are un-contactable for the whole day until you get back home? You can't just give someone a quick update with an SMS? The idea is just unfathomable.

What about going without air conditioning on those really hot summers days? Or without the internet or TV? The idea to go back to life without these things just seem impossible.

Well, this is the issue that our governments have at the moment in trying to repair a serious budget black hole. The government needs to save money but taking something away that we've become so accustomed to is met by fierce objection.

"Everyone in the last 10 years got a baby bonus or paid parental leave and I pay taxes so I should get it too."

Well no. If the government takes away some sort of benefit or welfare, there comes a point in time were someone doesn't get it.

It's just like queuing up for tickets to a sports game or concert and they sell out. Somewhere in the line, the person in front got tickets and you didn't and this needs to happen for government hand outs.

Baby bonus/paid parental leave, Family tax benefit, HECS and government assisted tertiary education, free* health care, age pension, any welfare for that matter.

I'm not saying all of these are bad and should be scrapped altogether, but something needs to change and as I said earlier, taking something away that we've had is very difficult to accept.

Look at the backlash and resistance to the proposal to increase the age pension age to 70. The outcries of the government making everyone work so long.  When the age pension was introduced, the qualifying age was 65 (for males) and our life expectancy was 63.  So living long enough to claim it was a good outcome. Now, it is seen as a right to get the age pension, and not just get it, but get it for 20 years.  The age pension age being 70 is not the retirement age. The retirement age is any age you want if you have enough money so the onus is on you if you want to retire earlier.

So, all that I ask is that before you just jump up and down at a proposal to remove some benefit to help repair the government budget and before you start sharing the hate photos on Facebook about how they have no right to take this or that away, just have a think about it and maybe share this blog instead (shameless plug). Sure, it would be nice if we could just have everything but unfortunately the world doesn't work like that. Politicians don't work on a bonus structure on savings they make and they don't have some psychiatric problem where they just want to see us suffer. Sometimes taking something away is for the countries long term benefit.

*Health care isn't free. It's just not on a user pays system so it 'seems' free.

The big risk for retirees and it's a good thing

So what could possibly be a big risk for retirees and be a good thing? Stock market crashes aren't a good thing. Reducing government assistance in retirement isn't a good thing. Inflation devaluing your assets isn't a good thing.  Well, the big risk for retirees is living too long. Advancements in modern medicine and better health is resulting in increasing life expediencies which means you need more money to support your retirement plans.

Having a life after you finish work, especially in good enough physical health to travel and enjoy yourself, is a relatively new concept and it is growing more and more. By that I mean, our life expectancy is growing rapidly, yet there is a large reluctance to work past peoples preconceived retirement age, just see the uproar when the government recently announced plans to increase the age pension age to 70 (from 67); Pension Plan Backlash. So what does this mean?

Well, lets just assume someone retires at age 65, even though some retire later and there are plenty that retire earlier, well they want to. At 65, the life expectancy for a male is 19.2 years and a female is 22.1 years. So, for a couple and working on round figures, we could work on 20 years, calculate an assumed rate of return, inflation and how much they want to spend each year and presto, we can work out how much money they need.

But that's the problem with a simple calculation like that, and that is, there are many many people living beyond their life expectancy, although not exactly, we'll say roughly half do. On top of that, the continual advancements of medicine and healthcare means we don't know what life expectancy is like in 10 or 20 years time. So, I'd put my money on well over 50% of 65 years olds will outlive their currently life expectancy.

So, therein lies the problem. If you have enough money for 20 years, are you then unlucky to live a healthy retirement past what your life expectancy was at age 65?

So, what do we plan for? Well, my opinion, longevity risk is a big risk for retirees these days. By the time you realise you are going to live too long for your assets to support, it's too late. There will be very little opportunity to go back to work and the Age Pension is borderline poverty at best and likely to get worse. So, I suggest when approaching retirement to plan on living to 95. Sure, you might spend less in the last 10 or 15 years of retirement than you do in the first 10 or 15 years, but that can be included in the calculations.

So, lets take a couple wanting to retire at age 65 and base a calculation on living to 95 and they are going to spend $58,188 for a comfortable retirement for a Queenslander (according to ASFA Retirement Standard) . That's 30 years. Assuming they achieve a rate of return of 7% and inflation of 3%, They would require just over $1,000,000 outside of their family home. Unfortunately, very few have that. But they can; engage a financial planner that is working in your best interest, that puts a plan together to get you to where you need to be and start early. The longer the plan is in place, the easier it is to achieve.

My name is Glenn Hilber and I am the owner and Senior Financial Adviser at Precision Wealth Management, an independently owned and licensed financial planning firm operating on a true fee for service basis. If you would like to discuss your retirement plans, contact me on 1300 200 012 or glenn@precisionwm.com.au

65% chance of recession in 2015.....apparently!

"65% chance of a recession in 2015" - This is the prediction put forward recently in a few media outlets and worryingly, the prediction is made by those who predicted the 1929 crash as the article states.  Is it really that worrying, or just another bit of media fodder to fill that blanks between the ads?

If we have a look at the story, Jerome Levy was a guy who flogged off his stocks  before the crash of October 1929 and these days has a forecasting institution named in his honour.  Sadly, Jerome is no longer is making these predictions because he died in 1967. Luckily though, the forecasting ability is genetic which has seemingly been passed to his grandson, David, and David is the one making the recession forecast for 2015.

David predicted the last financial crisis, which lends some authority to his calls and makes the latest prediction quite frightening. However, in all the stories of the wondrous Levy family forecasting, there is quite a few notable exceptions.

In 2010 Levy predicted a 60% chance of a US recession in 2011. The US grew by 1.7% in 2011.

A notable omission from Levy's previous predictions was a prediction made during an interview on March 9th 2009. The prediction was along the lines of asset values continuing to fall and multiple recessions ahead. And didn't he nail it? Not the prediction so much, but March 9 was the exact day that markets hit bottom and ended the bear market. Markets then proceeded to have a very strong bull market run.

Finally, in an interview with Bloomberg at the end of 2012, Levy said it was time to be defensive. Yet, 2013 saw 19% growth in Australian shares and 48% growth in international shares.

So, you see how this works, get a couple of calls right and the media will keep giving you plenty of attention and seemingly ignore all those wrong predictions. They ignore them because it ruins the entertaining part of their story. As they say a broken clock is right twice a day but I wouldn't really rely on a broken clock.

4 simple financial tips for young families

Often young families are very busy with their career and raising children that they can neglect a few simple things that can make a big difference over the long term.  I've put together a list of 4 tips for young families to implement which allows them to continue to get on with their busy lives knowing they are helping to set themselves up long term.

Tip 1 - Make sure your mortgage interest rate is low

A small difference in interest rate can make a huge difference. Don't just think you're too busy to worry about finding a deal that is 0.5% cheaper. You're stealing (or more so the bank is stealing) a large amount of money from your future self. If you are paying minimum repayments on a $300,000 mortgage at 5% and refinance to a 4.5% interest rate and keep paying the same repayments, you are a staggering $17,428 better off after 10 years.

This only applies to those who have a mortgage and not those who are renting. That's ok to be renting, but remember the alternative is paying off a house. You need to be making use of your cheaper living arrangements and saving/investing the surplus, it can't be spent. See the next tip.

Tip 2 - Budget to create a surplus

It is such a weird phenomenon that you can have someone earning $50,000 per annum and someone earning $100,000 and both spend everything they earn and both think there is nothing in the budget that they can do without. The reality is we can meet out basic human needs with much much less and everything else is desired spending. I'm not suggesting that everyone should be living on bread, dripping and living in a 3 bedroom shack with 4 other families but acknowledge that there are a lot of things in your budget that you are choosing to spend for today's lifestyle which is stealing from your future lifestyle. Just try to see what you can do with out and use the extra money to pay additional repayments into your mortgage, or into your savings/investment if you are renting. Once you are in the habit of trying to maximise your surplus each week, fortnight or month, you'll start to enjoy finding ways to maximise your surplus income. In that same example above of the person who has refinanced to a 4.5% mortgage, if they now also pay an additional $200/month into the mortgage, they have made an additional $24,000 in repayments over 10 years plus that has saved themselves $6,239 in interest on their mortgage. So just those 2 things alone put them almost $50,000 in front after 10 years.

Tip 3 - Check your superannuation

It really doesn't make much sense at all for young people to be in the balanced fund with roughly 30% in defensive assets (cash and fixed interest). They have such a long investment time horizon, they can withstand the volatility of the share market. A 1 or 2% better return over your working life can make an absolutely massive difference to your final superannuation balance.  Next time we get a major market crash, think of it as a good thing, your regular superannuation contributions are now buying low/cheap. You could even try tighten the belt and ask your employer to salary sacrifice so you buy even more during the next major downturn. To give you an example, a $50,000 balance with $5,000 per annum being invested would be worth $167,440 after 10 years with a 7% return. If that was a 9% return, it would be $26,893 more. Plus if you invested some extra during a major downturn, that could be even better. With compounding interest, the additional 2% return over 10 or 20 years after that starts making an absolutely massive difference.

Tip 4 - Ensure your personal insurances are sufficient

When people buy a new car, say it's worth $15,000, they don't even bare the thought of driving it out of the dealership without insurance because if that got written off, that $15,000 loss would be devastating. And then think, how much do you earn each and every year?  I can tell you, you will be able to withstand losing a $15,000 car a lot easier than going without your income for 1 year, let alone many years, or forever. Income protection is a must and if you have a family, death cover is also a must. I know we don't like to think about it but there are people dying prematurely every day from car crashes to medical conditions to even suicide (ABS states that there is almost 7 deaths per day from suicide in Australia and men account for 60% of them). Nothing will derail your family's financial position quicker than injury, illness or death.


My name is Glenn Hilber and I am the owner and Senior Financial Adviser at Precision Wealth Management. You can contact me on 1300 200 012 or glenn@precisionwm.com.au

Self Managed Superannuation Funds - What's the fuss

So, Self Managed Superannuation Funds or SMSFs or I have even referred to them as Smurfs (spoken, not written). They have become pretty popular over the past few years and I can't understand why. Well, I know why, but I think those reasons are a little bit misguided on the whole.

So many people are so disengaged from superannuation they haven't changed their super fund, insurances within the super fund, investment option or even consolidated their super funds when they've ended up with more than one, and now they want to take on the much more onerous task of managing a SMSF.

The reason people want a SMSF is because they believe it will result in a greater financial outcomes for them and that belief has mostly come about through the limited recourse borrowing rules that allows you to borrow to purchase investments. Whilst this is often used to buy property, it can also be used to buy shares or managed funds. However, the stats show that this is by far the minority. According to the ATO SMSF statistics from June 2013, limited recourse borrowing arrangements made up a staggering 0.5% of all SMSF assets.  The biggest holdings are 31.3% listed shares and 30.5% cash. What? Cash and listed shares, you can get them in retail super funds and some industry funds.

So, what about that magic balance when it is a good time to get a SMSF. Isn't it better when my super gets to $200,000? Well, if you are paying an administration fee for super that is 0.50% and the annual running cost of the SMSF is $1,000. Then sure. At $200,000 they are the same, then as the balance grows you are better off with the SMSF. And in some instances you may be willing to pay an increased administration fee in the short term to access the benefits of a SMSF. But what ends up happening a lot of the time is that you get the SMSF then go invest in an investment product where there administration fee for that product is roughly equal to the administration fee of the super fund you just got out of. Or even worse, it all gets too hard, the money goes in cash and stays there like the 30.5% of all SMSF assets. That would have really hurt over the past 5 years where diversified investments have returned about 10% and cash about 3%.

So, if you already have a SMSF, what is it invested in? Are you making best use of the fund or is it sitting in cash? Have you reviewed the investments? Make good use of it or wind it up. The accountant doing the fund returns each year isn't going to suggest you wind it up.

If you are thinking about starting a SMSF, have you thought about all the detail involved? Trustees? Are you going to have individual trustees or corporate trustees. As Noel Whittaker said recently "I can't see any reason to have individual trustees", well Noel, there is 1 reason and it is the reason why so many people choose individual trustees and that is cost. Do you know what happens to a SMSF if you have 2 people as individual trustees or directors of a corporate trustee and one dies or one because incapacitated? If you have a corporate trustee, who is going to be the shareholders and secretary? And make sure you're not just getting a SMSF, the SMSF should just be a tool for the investment strategy for you.

One of the big downsides to a SMSF is that it is almost impossible to make use of the anti detriment rules, so consider that carefully. I wrote about anti detriment in an earlier blog here

Also, if you are starting a SMSF, make sure you review your insurances as you will probably be forgoing insurances in your current super fund and also review your Estate Plan.

So, what do I think about it all? Well I think it's the flavour of the month and there are a lot of groups now promoting SMSFs. But it's like the sausage factory, everyone who comes in, gets a SMSF, but that is really not how it should work. They are definitely beneficial to some people who are willing to get involved, take the risk and utilise the strategies available. Whatever you do, don't spend the money setting it up, then let it be a drag on your superannuation wealth creation through lack of involvement.

If you would like advice on Self Managed Superannuation Funds, please contact me on 1300 200 012 or glenn@precisionwm.com.au