Opinion

Income in the new economic reality

By Greg Maclean
Global Head of Research, Infrastructure Sydney, Australia

I’ve operated my own SMSF for 15 years and, over this period, I’ve witnessed, first hand, massive changes in financial markets which have made building my fund balance much harder than prior to the GFC.

The main change has been very poor yields from international bonds. This should come as no surprise as, post the GFC, many governments have flooded markets with liquidity, driving down yields. This would be forgivable, if these so-called stimulus packages had actually stimulated economic growth. Unfortunately, 10 years after the GFC, we are seeing only scattered evidence of renewed growth among developed economies, led by the US. Many other countries have stagnant economies with massive levels of public debt.

Looking forward, it is not surprising that such countries are reluctant to join the US in reducing government stimulus. A contraction of liquidity would raise bond yields making servicing of their debt very difficult in a stagnant economy, without raising taxes.

That is, they have a vested interest in maintaining the status quo. In my view, this suggests bond yields will remain at low levels for at least the medium term.

Australia has been very fortunate in avoiding most of these problems. However, for better or worse, we are part of the global economy and the implications for SMSF trustees of a continuation of weak bond yields are profound.

In my opinion, the best strategy is for SMSF trustees to focus their investments more on growth over the longer term. This may mean that, rather than rely on bond yields, or dividends, they may have to draw on their savings on occasion.

The following table provides on a simple illustration of this proposition. It assumes two retirees start with a balance of $500,000. One adopts a “safe” bond reliant investment strategy which returns them an average 5% per annum over 10 years. The second targets a higher growth strategy which returns an average 8% over 10 years. It is assumed the second portfolio has a risk level typical of BBB rated corporate bonds, or a negative return one year in five. Both investors trim their withdrawals to ensure that the fund balance is roughly maintained over the period.

   Safe 5% Return Strategy  Growth 8% Strategy
Opening Balance Y1 $500,000 $500,000
Closing balance Y10 $500,190 $500,235

Annual withdrawals

(indexed to CPI)

 $23,000

 $36,000

 

The apparently riskier strategy still maintained capital over the period, but allowed more than 50% greater drawdowns to be sustained. The secret is to maintain good returns at an acceptable level of risk.

It’s easy to work it out which is the better option. However, there’s a marked reluctance for people to take that step and sell assets to fund their lifestyle. I think it’s a mental barrier that gets in the way and may be holding investors back from a more comfortable retirement.
SMSF investors need to reset their expectations when it comes to income-producing asset, because the world is not what it used to be and its unrealistic to expect the yields from bonds to recover to pre GFC levels any time soon.

In my opinion, SMSF investors need to consider alternative strategies, rather than tightening their belts to accommodate for low yielding investments.

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Important notes

While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455)  (AMP Capital) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided and must not be provided to any other person or entity without the express written consent of AMP Capital.

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