Investment risk is not something members of Australian super funds can avoid.
One of the strengths of the design of our superannuation system – from a public policy perspective – is that it is a defined contribution scheme. That gives us good marks on a global scale in terms of the system’s sustainability when compared to defined benefit schemes where governments or companies have the future liability to meet pension payments.
But it means that the investment risk sits with each of us as super fund members.
The actuarial profession has been built on measuring and managing risk and no-one loves a good projection more than your friendly local actuary.
This month the Actuaries Institute released a research white paper – For Richer, For Poorer – taking a detailed look at the state of the superannuation system broadly and its ability to deliver retirement incomes more specifically.
The good news out of the report is that super is generally doing its job of improving retirement incomes and reducing reliance on the age pension. Yes it can be improved and the Actuaries Institute voices strong support for the Financial System Inquiry recommendation that the objectives of the system ought to be enshrined in legislation.
The report proposes some guiding principles for the Government to consider when framing the super system’s primary objectives including sustainability, flexibility, equity and simplicity.
The 60+ page white paper delivers a comprehensive critique of the system and a wide range of scenario modelling for different cohorts of super fund members and retirees. For people looking to have a deeper understanding of the structure of our super system and the challenges that are being grappled with this is an independent, credible and accessible research paper.
In a defined contribution system investment outcomes are critical in determining how much super will be accumulated to fund a person’s retirement.
The white paper models a wide range of investment scenarios – for super and other household assets including property. It also provides a “stressed” example of how extreme investment outcomes – a worst case scenario if you will – would affect retirement savings.
This model is for investment outcomes in the bottom 5th percentile of results. The comforting news is that there is a 95% probability things will be better than this.
While the actuaries have clearly modelled an extreme stress test what it helps us understand is the range of potential outcomes.
The research paper projects wealth at age 65 for both couples and single households.
If we look at the median wealth results for couples – including super, non-super savings and home equity – for the 30-year-old cohort it is projected to be $1.34 million (adjusted for inflation) while a couple aged 60 would have about $1.2 million in wealth.
But if investment returns do languish at the lower end of the projections then the impact on the younger cohort is much more pronounced – down 30% – while the older cohorts are less affected with the drop in wealth around 10%.
The market scenarios that cause these results are different for the two cohorts. A significant short-term event like the global financial crisis in 2008 will drop the results dramatically for the 60-year-old cohort.
But for the younger 30-year-old cohort it would require sustained underperformance over a long period of time or perhaps multiple GFC-type events to drive investment performance down to lowest return percentile.
What the stress test is highlighting is just how hard it is to set a target savings figure and be confident of achieving it precisely. In any projection of where your superannuation account balance will be at retirement age the assumption you use for investment returns is a critical figure and what the Institute of Actuaries work shows is it is probably more realistic to look at a range of outcomes where you will be comfortable in retirement.
The Actuaries Institute research has stress-tested outcomes for a range of age cohorts as part of its comprehensive review of our super system. For the individual the task is much simpler – after all you know your age and your existing super account balance.
This is far from an academic exercise even if you are in the younger cohort.
Rice Warner were a key contributor to the Actuaries Institute modelling and their retirement calculator is available via the Vanguard website – where you can see just how differences in market returns impact how long your super balance will last.
Robin Bowerman is Head of Market Strategy and Communication, Vanguard Australia.
As a renowned market commentator and editor Robin has spent more than two decades writing about all things investment.