Thanks, Governor Glenn Stevens. Self-funded retirees don’t need reminding interest rates are really, really low. As if that wasn’t enough, then comes his observation that returns aren’t about to improve any time soon – and that retirees ought to get used to this.
If, indeed, low interest rates are here to stay for some time, there needs to be some serious re-thinking about what is happening to about a third of all super savings in Australia in the hands of SMSFs.
Reconsider minimum pension payments
And taking this a step further, the Reserve Bank governor’s scenario means SMSF members might need to start eating into the capital of their super savings much earlier than they planned. This is the inevitable result of likely low investment returns and the iron clad rules on minimum pension payouts, starting at 4% for those under 65 and rising to 7% for those 80 to 84 – as well as the demands of living costs.
If Governor Stevens’ predictions come to pass with several years of low returns, SMSFs could be in danger of becoming de facto annuity providers, paying out both earnings and part capital of members’ savings. That is, unless the government relents – as it did during the GFC – and temporarily reduces the minimum payout ratios.
This time Treasury might not be in any hurry; remember minimum payouts are designed to stop SMSFs becoming tax-free accumulation savings accounts to pass to the next generation.
Right now, looking in the rear view mirror, some SMSF investors might wonder what the fuss is about – the major super funds are currently earning around 14% a year and have earned more than 10% a year over the last three years. But those numbers are entirely due to the surging asset and stock markets here and overseas – and hardly a week goes by without a market flurry or doubts from various experts.
Alternatives
In the short-term, with perhaps half of SMSFs in pension paying mode, the immediate thought of most investors is to look for alternative sources of higher income. That’s easier said than done.
Unfortunately, low interest rates affect all investments and, in the search for slightly better returns, investors have to consciously decide to take more risks with their investments to get extra returns. Anyone who doesn’t realise this has forgotten the first principle of investment.
So, whether it is buying more hybrids, lower ranked fixed interest, listed or unlisted property or higher yielding shares, the chances are that any higher immediate income might come at the price of lower asset values. Buying more A-REITs, fixed interest managed funds or ETFs are possible strategies, subject to maintaining a sensible balance in the portfolio’s asset allocation.
But even for SMSFs not yet in pension mode, one sure way to lose money is to buy shares, which are at elevated levels. Even the much loved defensive stocks such as health care, banks and REITs are selling at price/earnings ratios which are well above their historical median PEs.
David Neal, head of the Future Fund, which is arguably Australia’s most professional investor, last week was the latest to warn about over-priced asset markets. He said in a quarterly report that “we are conscious that prospective returns cannot be expected to match the returns generated over recent years.” The Future Fund’s latest annual earning rate is 15.1% per annum – about the same as the last three years and ahead of comparable returns of around 12% for the average major super fund.
That has been achieved by using a much wider and more sophisticated mix of investments. For instance, at March 31, the Future Fund ‘s $117 billion portfolio had more invested in private equity ($11.3 billion) than in local shares ($9.6 billion) and more than $15 billion in property, infrastructure and timber lands. Another $16 billion was invested in alternative assets such as hedge funds.
The painful truth
This raises the question whether SMSFs can achieve the widespread diversification that might be needed to sustain future returns.
Finally, for some funds which have been taking profits and cashing up, it will raise questions of how long to take the pain of low returns from sitting in cash before hunting for bargains in the stock market. Going back to Glenn Stevens’ message, the inevitable conclusion is that some retirees may also need to curb their spending.
Important: 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. Consider the appropriateness of the information in regards to your circumstances.