Retirement today: the challenge of generating retirement returns and making them last

19 Aug, 2019

By, Dermot Ryan

Sydney, Australia

Once elected, one of the first things the new Morrison Government announced was a review of the retirement income system.

The review was proposed due to the increasing complexity of the current system and the challenges brought about by higher life expectancies, the impact of low interest rates and the lack of income available in many asset classes due to current lofty valuations.

In what will be a broad-based review it will look across the key tools to generate an adequate retirement income: the age pension, superannuation (including compulsory contribution levels) and savings outside super.

It will also address some divisive topics such as potential changes to the tax treatment of retirement savings, the role of the family home in retirement, and super contribution limits. It is quite an ambitious agenda that will give retirees and financial advisers much to think about in the months ahead.

Until we hear more about the direction of this review, we thought it would be interesting to take a look at the challenges of generating a reasonable income in retirement. When investing with a goal – such as retirement – in mind, it pays to think long-term. But there is no escaping the realities, and challenges, of today’s investment environment for retirees.

Impact of interest rate changes and high valuations

Interest rates have an impact on the investment landscape when they are low as well as high. Currently, interest rates are as low as they have ever been and this has driven valuations of defensive assets to unprecedented highs.

High valuations mean low yields and we are seeing record-low yields across many fixed income assets and some types of property. Term deposit rates are also at fresh lows following the Reserve Bank of Australia’s decision at its July meeting to drop the cash rate to one per cent, with expectations of more cuts to come later this year.

Low interest rates affect variables such as inflation and investment returns, and as such they have consequences for investment products. This has flow-on effects to all asset classes and, in turn, affects every Australian worker’s ability to save for retirement.

In the past, we had more options as investors – in the high interest rate era of the late 70s and 80s even relatively low-risk assets like term deposits and bonds offered double-digit returns. These days rates of return are all closer to one per cent.

Similarly, property yields in Australia are around two to four per cent depending on the type of property and geography.

Yields on Australian equities are still at 4.3 per cent before franking and about 5.5 per cent including franking. This shows that better yields are available but investors must either accept the valuation risk of defensive assets or take on more earnings risk in growth assets like equities, perhaps alongside a higher cash allocation.

The inflation perspective

Inflation has a big impact on retirees as they are in less of a position to accumulate capital after their working lives have finished. Falling returns mean providing for retirement is challenging, but although returns are low now compared to in the past, the view is not as bad when inflation is considered.

Inflation was running at around 15 per cent in the late 70s and 80s, which ate up much of the bond and term deposit returns mentioned above.

With inflation currently sitting at 1.8 per cent in Australia and returns for an average diversified fund at seven per cent, real returns don’t look so bad compared to two decades ago, taking into account the higher inflation levels of the time. Nevertheless, the combination of low interest rates and low inflation create a challenging returns environment for retirees.

There are risks too, should the current global inflation rate of about three per cent ever break higher than the defensive asset classes. As these assets are priced for the very low inflation of today, they would face major negative revisions. A reason, perhaps, to reduce valuation risk with a bar belled approach, increasing both cash and some growth assets.

The longevity conundrum

With Australians now living longer, another risk to retirement savings is longevity risk – the risk a retiree will outlive his or her savings. Back in 1980, a man starting a pension at age 65 had a life expectancy of 78 – an additional 13 years. Now, a male starting a pension at 65 has a life expectancy of 86 – an additional 21 years. While this is great news in many ways, it poses challenges financially as there are higher income needs as well as the need to grow the assets over time to make up for rising costs of living.

This is a particular concern in an environment which sees retirees drawing down on their pool of retirement assets because they can no longer generate sufficient income returns. This means retirement account balances are being depleted relatively quicker than in the past, especially if retirees lack exposure to growth assets to generate some capital growth over their longer lives.
No easy solutions

Supporting an ageing population to achieve their retirement goals in a market of lower investment returns is one of the major challenges facing our society and financial services businesses. A stable policy framework for superannuation and a long-term approach will be important in giving retirees the best chance of achieving a comfortable retirement.

 

 

 

 

Olivers Insights: Plunging bond yields & weak share markets amidst talk of recession – what does it mean for investors?

Introduction

Only last month share markets in the US and Australia were at record highs. But ever since President Trump ramped up the US-China trade war again at the start of August, financial markets have seen a significant increase in volatility. Share markets have had a 6% or so fall from their highs to recent lows and bond yields have plunged to new record lows in many countries. This note takes a look at what is driving the market turmoil, the risk of recession and what it means for investors.

Market Turmoil – what’s driving it

The bout of market turmoil we have been seeing this month basically has three inter-related drivers. First, President Trump ramped up the US-China trade war again with another round of tariffs on China.

Second, Chinese economic data showed more than expected in July and the manufacturing heavy German economy contracted in the June quarter. This is on the back of weak global data.

Third, economic uncertainty drove more money into bonds pushing bond yields down and driving a further “inversion” of bond yield curves – which is when long-term bond yields fall below short-term yields – leading to more talk of recession.

This all drove share markets down. Of course, the turmoil in Hong Kong, Brexit, tensions with Iran, political uncertainty in Italy and increasing risks that a Peronist government will return in Argentina aren’t helping. Talk of policy stimulus has provided some relief though with occasional sharp rallies in shares.

Australia is not in the trade war but anything that weakens global growth threatens our exports and confidence, so we are naturally seeing bouts of weakness in Australian shares and bond yields just like we did last year when the trade war started.

Reason for concern

There are several reasons for concern. First, the trade war still shows no sign of letting up. Optimism on US trade talks with China have been dashed several times now, the threat of tariffs on autos remains and maybe China has decided to wait till after next year’s US elections.

Second, the trade war and the twists and turns it takes is weighing on business confidence and it’s hard to make firm investment plans when they may be rendered uneconomic by a tweet from Trump. This is particularly evident in a slump in manufacturing conditions PMIs worldwide. See the next chart.

Third, it’s been hoped Chinese policy stimulus will offset the trade war for the last year now, but China has continued to slow.

Fourth, inverted yield curves have preceded post-war US recessions so the recent inversion can’t be ignored.

Finally, global and Australian share markets are vulnerable to weakness after roughly 25% gains from their December lows to their July highs left them overbought and vulnerable to a correction. This risk is accentuated as the August to October period often sees share market weakness.

Reasons for optimism

However, while the risks have increased there are several reasons not to get too concerned. First, President Trump is getting twitchy about the negative economic effects of the trade war: he delayed some tariffs last week after some sharp share market falls and had a meeting with major US bank heads on share market falls. The historical record shows that US presidents get re-elected after a first term (think Nixon, Reagan, Clinton, Bush junior and Obama) except when there were recessions in the two years before the election and unemployment is rising (think Ford, Carter and Bush senior). Trump would be aware of this. Share markets have regular corrections but major bear markets are invariably associated with recession and so Trump is wary whenever shares take a sharp lurch lower. As a result, our view remains that at some point Trump will seek more seriously to resolve the trade issue.

Second, policy stimulus is being ramped up: with numerous central banks now cutting interest rates and indicating that more cuts are on the way including from the Fed; the ECB looks like it will soon return to quantitative easing; Chinese economic policy meetings indicate that more policy easing is on the way; Germany is reportedly thinking about some sort of fiscal stimulus; and there is talk of more US tax cuts. This is very different to last year when the Fed was tightening, the ECB and ended QE and other central banks including the RBA looked to be edging towards tightening.

Third, while the risks have increased, a US or global recession remains unlikely: services indicators have held up well (see the first chart) and the services sector is the dominant part of most major economies; we have not seen the sort of excesses that precede global and notably US recessions – there has been no investment boom, private sector debt growth has been modest and inflation is low such that central bankers have not slammed the brakes on; & monetary and fiscal stimulus will provide support.

Finally, the decline in bond yields is making shares relatively cheap. The gap of 4.8% between the grossed-up dividend yield on Australian shares of 5.7% and the Australian 10-year bond yield of 0.94% is at a record high. Similarly, the gap between the grossed-up dividend yield and bank term deposit rates of less than 2% is very wide. In other words, relative to bonds and bank deposits shares are very cheap which should see them attract investor flows providing we are right and recession is avoided.

But what about inverted yield curves?

Long-term bond yields should normally be above short-term bond yields because investors demand a higher return to have their money locked away for longer periods. But sometimes long-term rates may fall below short-rates. This happened briefly in the US in the last week in relation to the gap between 10-year and 2-year bond yields but had already happened a few months ago in relation to the gap between 10-year yield and the Fed Funds rate. See the next chart.

This so called “inversion” is causing increasing consternation as an inverted US yield curve has preceded US recession so it’s natural for investors to be concerned. But the yield curve is not necessarily a reliable recession indicator at present: it can give false signals (circled on the next chart); the lags from an inverted curve to a US recession averaged around 18 months in relation to the last three recessions so any recession may be some time off; various factors unrelated to US recession risk may be inverting the curve such as increasing prospects for more quantitative easing pushing down bond yields, negative German bond yields dragging down US yields and investor demand for bonds as a safe haven from shares; yield curves may be more inclined to be flat or negative when rates are low; and as noted earlier we have not seen other signs of an imminent US recession such as over-investment, rapid debt growth, excessive inflation and tight monetary policy. So, our base case remains that a US recession is not imminent.

The Australian yield curve has also gone negative with 10-year bond yields of 0.94% below the cash rate of 1% but the gap between the 10 and 2-year bond yields only just positive. But it’s worth noting that Australian yield curve inversions around 1985, 2000, 2005-2008 and in 2012 were useless recession indicators.

What does this all mean for investment markets?

In the short-term share markets could still fall further as trade and growth uncertainties remain as we go through the seasonally weak months ahead. This could be associated with further falls in bond yields. In fact, further share market weakness may be needed to get Trump to seriously resolve the trade issue (as opposed to just go through another trade talks/ breakdown cycle again).

However, providing we are right and recession is avoided, a major bear market in shares (i.e. where share fall 20% and a year later are down another 20% or so) is unlikely and given that shares are cheap relative to bonds we continue to see share markets as being higher on a 6-12-month horizon.

What should investors do?

Since I don’t have a perfect crystal ball, from the perspective of sensible long-term investing the following points are repeating.

  • First, periodic sharp setbacks in share markets are healthy and normal. This volatility is the price we pay for the higher long-term return from shares. After 25% or so gains from their lows last December shares were at risk of a correction.
  • Second, selling shares or switching to a more conservative strategy after falls just locks in a loss. The best way to guard against selling on the basis of emotion is to adopt a well though out, long-term investment strategy.
  • Third, when growth assets fall, they are cheaper and offer higher long-term return prospects. So, the key is to look for opportunities that pullbacks provide.
  • Fourth, while shares may have fallen in value, the dividends form the market haven’t. The income flow you are receiving from a diversified portfolio of shares remains attractive. So for those close to or in retirement they key is to assess what is most important – absolute stability in the value of your investments or a decent sustainable income flow
  • Fifth, shares often bottom at the point of maximum bearishness. So, when everyone is negative and cautious its often time to buy
  • Finally, turn down the noise. In times of crisis the negative news reaches fever pitch, which make sit very hard to stick to a long- term strategy, let alone see the opportunities.

Escalating US-China trade war

Introduction:

After a third round of talks made little progress last week, the US/China trade war has escalated badly with tit for tat moves on an almost daily basis by each side. This has seen share markets fall sharply with US, global and Australian shares down about 5-6% from recent highs and safe haven assets like bonds and gold benefiting on the back of worries about the global growth outlook. This note looks at the key issues.

What is a trade war?

A trade war is where countries raise barriers to trade with each other usually motivated by a desire to “protect” jobs often overlaid with “national security” motivations. To be a “trade war”, the barriers need to be significant in terms of their size and the proportion of imports covered. The best-known global trade war was that in 1930 which saw average 20% tariff hikes on US imports.

What is so good about free trade?

A basic concept in economics is comparative advantage: that if Country A and B are both equally good at making Product X but Country B is best at making Product Y then they will be best off if A makes X and B makes Y. Put simply, free trade leads to higher living standards and lower prices whereas restrictions on trade lead to lower living standards and higher prices.

So why is President Trump raising tariffs then?   

It’s basically about fulfilling a presidential campaign commitment to “protect” American workers from what he regards as unfair trading practices in countries that the US has a trade deficit with – notably China. And he knows this is popular with his supporters but there is also some degree of bi-partisan support for taking on China.

What does President Trump want?

Basically, he wants China to lower its tariffs, allow better access for US companies, end US companies being forced to hand over their technologies and protect intellectual property of US companies. At a high level he wants a reduction in America’s trade deficit with China. Along the way he has renegotiated the NAFTA free trade agreement with Mexico and Canada and the free trade deal with South Korea and is in talks with Europe and Japan. In recent times he has also used the threat of tariffs to get what he wants from countries (e.g. Mexico in relation to border protection).

Where are we now?

Fears of a global trade war kicked off in March last year with Trump’s announcement of a 10% tariff on aluminium imports and a 25% tariff on steel imports. US allies were subsequently exempted but China was not. On March 22 Trump announced 25% tariffs on %US50bn of US imports from China. These were implemented in July and August. After Chinese retaliation Trump announced a 10% tariff on another $US200bn of imports from China (implemented in September) which would increase to 25% on January 1 this year. The latter was delayed as the talks made progress.

However, following May 5 tweets by Trump, on May 10 the delayed tariff hike from 10% to 25% on $US200bn of imports from China was put in place and the US kicked off a process to tariff the remaining roughly $US300bn of imports from China at 25%. If fully implemented this would take the average US tariff rate on imports to around 7.5%, which is significant (albeit minor compared to the 20% 1930 tariff hikes). See next chart.

Along the way, China’s retaliation has been less than proportional, partly reflecting lower imports from the US. The US has also put in place restrictions on dealing with Chinese tech companies like Huawei.

Following a meeting in late June between Presidents Trump and Xi the trade war was put on hold pending a third round of talks. These look to have made little progress and Trump announced last week that from September 1 the remaining $US300bn of imports from China will be taxed at 10% and this may go beyond 25%.

China has responded by allowing the Renminbi to fall below 7 to the US$ and reportedly ordering state-owned enterprises to halt imports of agricultural products from the US. The US then named China a currency manipulator (even though basic economics pointed to a fall in the Renminbi in response to the tariffs on its good) which opens the door to possibly further action by the US (e.g. intervention to lower the $US versus the Renminbi) then potentially a further escalation in the trade war.

At the same time, the US is still considering auto tariffs after a report lodged in February.

What happened to the US/ China trade talk?

This has been the third round of trade talks that look to have failed. The timing of the announcement of the latest round of tariffs may also reflect a desire by Trump to force the Fed to ease more as he wasn’t happy with its 0.25% cut last week and to show that he is tougher on trade than far-left Democrat presidential candidates Sanders and Warren. Whatever it is, there is likely to have been a further breakdown in trust between China and the US and China may have decided to wait till after the election.

Ongoing tensions around North Korea, Iran, Hong Kong, Taiwan and the South China sea are probably not helping the issue either.

What will be the economic impact?

The latest round of tariffs increases from September 1 would be a big deal compared to last year’s tariffs and see the impact shift to largely consumer goods as opposed to intermediate goods in the first tariff rounds. The 10% tariff could knock around 0.3% from US and Chinese GDP particularly as investment gets hit in response to uncertainty about supply chains. The full 25% tariff could take that to around 0.75% with roughly a 0.2% boost to US core inflation (albeit this would be temporary and looked through by the FED). This would flow on to slower global growth and lead to less demand for Australia’s exports even though we are not directly affected.

What is the most likely outcome?

At this point, it’s hard to see a way out of the escalating trade war and it risks flowing into others issues as well including around HK, Taiwan, and the South China sea as the US and China slip further towards some sort of “cold war”. However, As the economic impact in the US mounts -so far, it’s just been impacting business confidence and investment plans but risks impacting consumer spending too – President Trump is likely to become more concerned. Recessions and rising unemployment have historically killed the re election of sitting presidents (Hoover, Ford, Carter and Bush Senior) and for this reason, we remain of the view that a deal will be reached before the election. President Trump showed late last year that he was sensitive to the impact of the trade conflict on the US share market (as after sharp falls he called President Xi to set up a new meeting). So sharp share market falls may be needed again to get the US and China negotiating. But this means it could still get worse before it gets better – The US share market had a top to bottom fall last year of 20%!

It’s also worth noting that policy stimulus by the FED and Chinese government will offset some negative impact which along with the absence of the sort of excesses (like in cyclical spending, inflation and private debt) that normally precede recessions in the US is why we are not predicting a recession.

What does it mean for investment markets?

Basically, the uncertainty around the escalating trade war is bad for listed growth assets like shares as it threatens the outlook for growth and profits, but positive for safe-haven assets which is why bond yields in many countries including Australia have pushed further into record low territory and gold has increased in value.

Following last week’s highs, global and Australian shares have fallen roughly 5-6%, mainly reflecting concern about the impact on growth from the escalating trade war. Further downside is likely in the short term as the trade war continues to escalate and we are also in a seasonally week part of the year for shares. This is likely to be associated with further falls in bond yields.

However. Providing we are right and recession is avoided, a major bear market in shares (i.e. where shares fall 20% and a year later are down another 20% or so) is unlikely.

What does it mean for Australia?

Fortunately, Australians aren’t having to pay higher taxes on imports like Americans, but the main risk is that we are indirectly affected as the US/ China trade war drags down global growth, weighing on demand for our exports and leading to unemployment pushing higher than our 5.5% forecast for year end. This all adds to the case for further easing by the RBA (we expect the cash rate to fall to 0.5% by February) and for further fiscal stimulus.

What should investors do?

Times like the present are stressful for investors. No one likes to see their wealth fall and uncertainty seems very high. I don’t have a perfect crystal ball, so from the point of sensible long-term investing the following points are worth bearing in mind:

  • First, periodic sharp setbacks in share markets are healthy and normal as can be seen in the next chart. The setbacks are the price we pay for higher long-term return from shares. After 25% or so gains from their lows, last December shares were at risk of a correction.

  • Second, selling shares or switching to a more conservative strategy after a major fall just locks in a loss. The best way to guard against selling on the basis of emotion is to adopt a well thought out, long-term investment strategy.
  • Third, when growth assets fall, they are cheaper and offer higher long-term return prospects. So, they key is to look for opportunities that pull-backs provide.
  • Fourth, while shares may be falling in value, the dividends from the market aren’t. The income flow you are receiving from a diversified portfolio of shares remains attractive.
  • Fifth, shares often bottom at the point of maximum bearishness. So, when everyone is negative and cautious it’s often time to buy.
  • Finally, turn down the noise of financial news. In periods of market turmoil, the flow of negative news reaches fever pitch, which makes it very hard to stick to a well-considered long term strategy, let alone see opportunities.

 

Dr. Shane Oliver, Head of Investment Strategy and Chief Economist.

Money mistakes people make in their 50’s and 60’s

Avoid these common money traps to make sure you have enough put aside for a comfortable retirement.

When you’re in your 50’s and 60’s, you know you’ve worked long and hard for what you’ve achieved in life and probably have a fair idea of how you want to live in your future retirement. But it’s important not to become complacent and ignore the warning signs of not having enough money for retirement.
Here are some common money mistakes and suggestions on how to avoid them:

1. Accessing super too early

One of the most common mistakes people make is to start using their super too early, such as when they reach their preservation age. This can leave a significant shortfall in retirement savings when you need it most.

To avoid falling into this trap, ask yourself:

  • How long am I going to need to live on my retirement funds?
  • How much money do I have saved in my super now, and is it enough?
  • What other sources can I draw on to supplement my income?

If you’re not sure about the answers to these questions, you can access the how much super do I need article from the AMP website. Use the AMP super simulator to work out how much you could save by making extra contributions to your super.

2. Underestimating retirement

Another common oversight is not preparing well enough in advance for retirement. Learn about how to prepare for retirement and then start thinking about ways you can boost your retirement savings now.

One way to save more for retirement is to consider a transition to retirement strategy. If you are aged 55 or over and still working, you can either work less hours for the same income or work the same hours to give your super a tax-effective boost. Talk to us to find out if this strategy is right for you.

3. Counting on the Age Pension

Some people think they will be able to survive on the Age Pension, but this will only provide a basic standard of living in retirement.i If you want to be able to afford a few luxuries, such as a new fridge or the occasional holiday find out about saving for a comfortable lifestyle in retirement.

4. Not claiming on entitlements or government benefits

Be aware of any entitlements or what you can claim to stretch your dollar further in retirement. Find out now if you will be eligible for government benefits or other payments and visit the AMP website to find out how to make the most of your retirement entitlements.

5. Being unaware of investment risks

Just because you’re nearing retirement doesn’t mean you should put your retirement savings at risk for the sake of higher returns. Make sure you have a diversified portfolio and are aware of things to watch out for when you are investing and retirement investment risks.

6. Supporting adult children and aged parents

People in their 50’s are sometimes referred to as the ‘sandwich’ generation where they’re tasked with looking after their own children, as well as their elderly parents. Visit the AMP website to read about how not to put your retirement plans at risk when the kids won’t leave home or to fund aged care options.

7. Prioritising home loan debt over other debt

It’s no use building savings, if you still have financial pressure from other debts hanging over your head in retirement. Think about prioritising other debts before tackling your home loan debt, or consolidate all your debts into a home loan with a lower interest rate. Check out the AMP education module on paying of debt.

8. Not having a valid, current and legally binding will

Having a valid, current and legally binding will removes the burden on loved ones and avoids any confusion after your passing about how you want your assets to be distributed. If you decide to make your own will, make sure it is checked by a solicitor, otherwise your beneficiaries may not be entitled to receive any of your estate.
Also, check your appointed executor knows exactly where your personal documents are kept and that they are aware of their responsibilities.

Still need help?

If you’d like help with any of these areas, speak to us to discuss your personal circumstances.

i http://www.superannuation.asn.au/resources/retirement-standard

© AMP Life Limited. First published 14 June 2017

Oliver’s Insights – The longest US economic market expansion ever…

The cyclical bull market in US shares is now over 10 years old. This makes it the longest since WW2. A bull market is defined as a market in which share prices are rising, encouraging buying.

Where the US economy goes is critical to the outlook for shares, including the Australian share market.

This article discusses why economists are expecting US – and hence global and Australian – shares to experience further growth in the next 6-12 months.

Our Office is Growing

A big welcome to Zoe Parker, who will be joining the Casey Wealth team as our new administration assistant! Zoe has been helping Lisa and Haley out in the office over the past couple of weeks, and will start with us full time in July, once she is back from her holiday to Europe. We’re very excited to have a fresh face in the office!