27 September 2023

Plan ahead: How to invest for retirement in a low interest rate world

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Rod Myer* says a low-risk, high-income retirement option is no longer a reality for many Australians.

The idea of moving your superannuation into conservative assets and enjoying your nest egg as you move into retirement has been shattered by the fall of interest rates in recent years.

A term deposit once paid 5 per cent interest, but now the figure is more like 1.49 per cent a year and 1.36 per cent over five years, according to Canstar.

That means a low-risk, high-income retirement option is no longer a reality for many people.

Carlos Cacho, an economist at investment bank UBS, said that won’t change any time soon.

“We think the Reserve Bank cash rate will fall further to 0.25 per cent [from the current 0.75 per cent], which will pressure the banks to cut mortgage and deposit rates,” Mr Cacho said.

The bond market is signalling the same, with yields on Australian Government 10-year bonds falling to 0.88 per cent after a brief rally in December.

Weaker bond yields mean “Australia has joined the international trend”, according to Charlie Jamieson of Jamieson Coote Bonds.

“And we’re not going back to 3 to 5 per cent for a long, long time,” he said.

The saviour for super returns in recent years has been the fact stock markets have boomed while interest rates have slumped.

This saw average returns on balanced or growth funds, where most Australians invest their super, jump to a stunning 14.7 per cent a year.

(These funds have between 61 and 80 per cent in growth assets.)

Meanwhile, Australian shares returned 23.8 per cent and international shares made 28 per cent last year, which has made markets look a bit frothy.

“We had a pretty big run last year and a repeat of that is unlikely,” said Ned Bell, investment manager with Bell Asset Management.

Globally, markets “aren’t overly expensive with PEs [price equity ratios] of 17 times”.

But Mr Bell says growth is available in niche areas that are generally not available to pooled super fund members.

Mano Mohankumar, researcher with Chant West, also said recent super returns “aren’t sustainable over the long term”.

“With record-low interest rates and low inflation, asset prices have risen to levels that are at or approaching full valuation,” he said.

What to do?

If you are, or soon will be, relying on your super for income support, there are strategies you should consider.

David Simon, Principal of Integral Private Wealth, says sticking with a balanced strategy, especially if you have a relatively small balance, is extremely risky.

“You will get hurt if the market falls and you will never, ever get back to where you were,” Mr Simon said.

That’s because you have to sell units every year to achieve a certain income, and after a share market rout you will be selling more units to get the same return.

Put aside some funds to live on

“The first thing to do is work out your cash flow — what you need to spend to live,” Mr Simon said.

“Then restructure your super fund so you have two years’ necessary income in cash, three years’ in fixed interest and the rest in a diversified option.”

“Ask your fund to pay your annual income from the cash,” Mr Simon said.

“If the market falls, you avoid having to sell growth assets at a discount and you can use your fixed-interest allocation to buy back into shares.”

Chris Morcom, a certified financial planner with Hewison Private Wealth, says be careful about retiring too early.

“Keep working if you can,” Mr Morcom said.

“If you expect a comfortable retirement investing in term deposits, you will be disappointed unless you have a huge pot of money.”

“If you’re not aware of the options in super and investment then you’re selling yourself short.”

“So, get advice and review your situation regularly.”

“Look at where your money is and ensure you have the appropriate allocation between defensive and growth.”

Be countercyclical

Regular rebalances enable you to keep your money working optimally.

“If equities grow strongly, you can take some profits to boost your cash and, if they fall, you can invest more,” Mr Morcom said.

Given that interest rates are so low it is tempting to invest in equities and property trusts — but Mr Morcom said chasing yield in these areas “is not low risk”.

Meanwhile, fixed-interest funds will fall in value if interest rates rise, as bond prices move inversely with yield.

“If you need, say, $30,000 to top up your income needs, then that’s what you need,” Mr Morcom said.

However, rather than increasing risk for higher returns, you might be better off using more capital in the short term.

“If you turn 65 today, you can expect a long retirement, so you might want to plan to be funded more from a part-pension later on,” Mr Morcom said.

All the strategies referred to above can be used in industry, retail, public sector and self-managed super funds, as well as non-super investments.

It is recommended to take advice from a qualified adviser before acting.

* Rod Myer is a journalist and Editor of YourSuper. He tweets at @RodMyer1.

This article first appeared at thenewdaily.com.au/finance/superannuation/.

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