Pre­pare for the worst

Re­tirees who plan ahead will be bet­ter equipped to ride out any shock

Money Magazine Australia - - SUPER -

To what ex­tent should su­per funds pre­pare their mem­bers for a mar­ket cor­rec­tion and give them strate­gies to min­imise the im­pact? Dur­ing the GFC many peo­ple pan­icked and fled to the safety of cash, only to lock in their losses. This was es­pe­cially the case for pre-re­tirees and those in re­tire­ment. The prospect of tak­ing an­other hit at the end of their work­ing lives prompted many to be­come risk ad­verse and seek safe har­bour in low- risk, low-re­turn in­vest­ments.

Fi­nan­cial con­sul­tant Rice Warner says funds need to be more proac­tive and help mem­bers man­age mar­ket volatil­ity bet­ter. Its re­port “Pre­par­ing Mem­bers for a Mar­ket Down­turn” shows how a “bucket strat­egy” of stick­ing to growth will out­per­form in­vest­ing higher pro­por­tions in cash and switch­ing to cash at the bot­tom of the mar­ket.

“When peo­ple are up­beat about the econ­omy, prices of­ten rise ex­u­ber­antly. When the mar­ket turns down sig­nif­i­cantly, it is usu­ally fast and with­out no­tice,” ac­cord­ing to the re­port. “So while we can say that in­vest­ment mar­kets fol­low a cycli­cal pat­tern, no one can pre­dict when the mar­ket will rise or fall. We also know that mar­kets usu­ally re­cover their losses over time, some­times quite quickly.”

While de­fault su­per funds have been pos­i­tive for each of the past nine years, with many close to, or above, dou­ble-digit re­turns, Rice Warner warns that a share­mar­ket re­ver­sal is be­com­ing more and more likely. “Could we have a neg­a­tive 25% re­turn on eq­ui­ties lead­ing to a 10% or more fall in fund re­turns this year or next year? If the mar­kets do take a step back, this will have a big im­pact on su­per funds and their mem­bers, par­tic­u­larly the grow­ing numbers of re­tirees.”

The ef­fects could be mag­ni­fied for mem­bers who find that they are bear­ing more in­vest­ment risk than they re­alised and lock in losses by mov­ing to more de­fen­sive strate­gies at an in­op­por­tune time. “Rather than wait­ing un­til the event, funds should pre­pare now through ac­tive com­mu­ni­ca­tion to those at risk.”

Rice Warner ques­tions the in­vest­ment re­turn tar­gets of many funds – typ­i­cally CPI plus 3%-4% over a rolling 10-year pe­riod – and says they need to ask them­selves whether these tar­gets are re­al­is­tic and com­mu­ni­cate the risks to mem­bers.

Since ex­pe­ri­ence from the previous fi­nan­cial crises shows that many mem­bers will switch out of growth as­sets into cash at the bot­tom of the mar­ket and se­lect in­vest­ments that lead to lower re­turns, Rice Warner calls for more tai­lored ad­vice.

For those close to or in re­tire­ment who will have liq­uid­ity needs, funds should en­cour­age mem­bers to cal­cu­late their forecast pen­sion pay­ments and put away up to 18 to 36 months of their ex­pen­di­ture needs into a “cash bucket”.

Ex­cess in­vest­ment re­turns or in­come from div­i­dends could go into this bucket to re­duce down­side risk.

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