Although 25 years have passed since compulsory superannuation was introduced in Australia, the goal of ensuring that people are sufficiently funded in retirement is yet to be met. Those who were new entrants to the workforce in 1992 are now mostly only halfway through the nest egg accumulation phase. Similarly, many of those who were older are realising that their superannuation balances remain insufficient to provide a sustainable retirement income.
Accordingly, ensuring that individuals have enough income throughout retirement is a crucial issue for governments, policy makers, superannuation trustees and investment managers in Australia, and globally.
To date, the attention of regulators and industry practitioners has been concentrated on maximising the efficiency of investment strategies that focus on the accumulation or wealth creation phase. However, amid a burgeoning growth in retiree numbers there remains a limited choice of investment strategies that deal with the draw-down or wealth consumption phase.
Adequacy of retirement funding is measured internationally by income replacement ratios. These estimate the percentage of final employment income required to sustain a comparable standard of living in retirement. The OECD currently suggests that the replacement ratio for median income earners is 70% of final earnings.
Income inadequacy in retirement implies that frugality becomes necessary for affected retirees. This may lead to increased stress, which negatively impacts health and wellbeing.
When considering the issue of adequacy of funding in retirement, AMP Capital CIO iPac and Head of Investment Solutions Jeff Rogers says that retirement is no longer a point in time defined by age. It is a transition.
Investment strategies need to re-align to reflect this reality. In practice, investors need a range of alternatives to address the myriad of circumstances they face.
Effective future retirement solutions should cater to the different goals individual retirees may have and, importantly, should consider the size of individual superannuation account balances.
When formulating investment strategies, investors should remain mindful that interest rates and investment yields are likely to be significantly lower in coming years than in the 20 years preceding the GFC. Hence, retirees who focus their investment strategy on cash and term deposits risk achieving poor funding outcomes.
In tandem with the prospect of modest yield returns, the suitability of the traditional diversified fund approach no longer appears behaviourally optimal.
Instead, it appears preferable to pursue an approach that allows the segmentation of goals and an ability to monitor progress towards the achievement of these goals. Doing so would be likely to significantly improve financial wellbeing in retirement by providing more transparent linkages between investment strategies and the spending goals of retirees.
AMP Capital’s experience is that a goals-based approach to investing is beneficial because it starts with a deeper understanding of an individual’s behaviour and the relative priority of their financial goals.
It is our view that there needs to be a richer suite of post-retirement products oriented around the goals of retirees. No single product can be expected to deliver suitable outcomes for all. Developing investment strategies that better meet the goals of retirees requires some re-thinking of traditional investment challenges.
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