Many people throughout their working lives take the default option of a balanced fund in accumulating their superannuation. However, a balanced fund alone when taking a pension during volatile times could erode your retirement savings significantly.

A balanced fund might be expected to return around 7% per annum, as assumed by the Association of Superannuation Funds of Australia (ASFA). But, owing particularly to the equity component of the fund, returns may vary quite significantly from year to year. This volatility is not much of a problem if, over time, the fund is in line with average returns, particularly in the accumulation phase. But when it comes to taking a pension, the need to draw down on the dips can really curtail the life of the fund.

Expected returns

Over the past five years to September 2011, the median return on a super fund, as calculated by SuperRatings and published in the Sun Herald, was 0.92% per annum. The worst performing industry super fund returned -1.87% a year and the worst other fund, -2.78% a year over that time.

All three figures fall a long way short of the 7% assumption used in the ASFA calculations that I discussed in my previous column. As a re-cap, ASFA’s calculations showed that a balance of $850,000 would last a couple about 22 years if a comfortable pension of $55,080 is withdrawn each year.

Dismal results

If a return of 0.92% per annum were experienced in the first five years of retirement, and inflation remained at 3% per annum, the above hypothetical fund would last, not 22 years, but just over 15 years – and that’s assuming the return goes back to 7% per annum after five years.

For the worst industry fund, a ‘comfortable’ standard of living would last nearly 13 years, and just over 12 years for the worst other fund.

If these figures seem bad, consider now that the hypothetical fund did not experience, say, the same 0.92% per annum for the first five years, but experienced volatility along the way within that five year period – as happened in reality. Unfortunately, the data are not readily available in order to perform those calculations. But, if the worst results started nearer the beginning of retirement, the longevity of the fund would be even less – possibly much less than the 15 years in the above example.

A better option

Consider now a retired couple who put three-years’ worth of living expenses in cash (3 x $55,080) that only earned the rate of inflation, which is about 3%. They put the rest in the balanced fund, which earned the realised rates of return for five years (say 0.92%, -1.87% or -2.78%) after which it earned 7% per annum. This couple use the cash to fund their pension in the bad early years to avoid drawing down on the fund.

Following this approach that insulates the fund through three of the bad years, the worst fund that lasted just over 12 years in the above example, would now last nearly 17 years with the hybrid but segregated cash and balanced fund!

Avoiding draw downs

The problem with making draw downs on a fund is that all of the asset classes covered are usually drawn down at the same time. That is why the segregated cash fund and the balanced fund in the last example works so much better.

Of course, the results vary depending on when the bad years occur. In my next column, I will discuss some alternative strategies for making super funds last a bit longer in pension mode.

Ron Bewley, executive director of Woodhall Investment Research.

Watch Ron discussing annuities with Peter Switzer on Super TV.

Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Anyone should, before acting, consider the appropriateness of the information in regards to their objectives, financial situation and needs and, if necessary, seek professional advice.