Preparing For A Retirement Crisis
Updated: Dec 18, 2019
Hunting for Yield in a low Income World
As I’m typing this the S&P 500, Nasdaq are at record highs while despite being a laggard over the past few years the ASX 200 is a miniscule step away from a record high as well.
On the surface this sounds like a fantastic scenario for investors. It’s difficult to be unhappy when the value of your capital is as high as it has ever been.
The problem though is that the income investors are able to generate from their investments is as low as it has ever been. As I scan my eye across global markets, yield is at tremendously low levels (including many countries where yields are actually negative!). That’s right, owning cash or bonds will actually cost you money!
Why are there so many retiree’s in a desperate income position?
The Traditional Retirement Plan
Back in 1990 a relatively safe 10 year Australian Government bond was paying about 13.50% in interest payments a year. Certainly, a very solid return for retiree’s to live off without eating into their capital to fund living expenses. Since then however, bond yields have been on a long term structural decline with the Australian 10 year bond currently offering a yield of 1.15%.
Or for my typical retiree client, a return of $11,500 on a $1,000,000 investment. Relatively safe but with a return like that you will be forced to start to use capital to fund living expenses quite quickly. Unfortunately, even for a single homeowner in a country town, it would be borderline impossible to live a reasonable standard of life on an income of $11,500.
Just remember, this is the return on a $1,000,000 investment. For an investor with “only” $500,000 to invest, the return drops down to $5,750 per annum (aged pension eligibility not withstanding).
Are we in the beginning of a retirement crisis?
Let’s go back to the Global Financial Crisis to get a little context about where we are now.
As wave after wave of subprime loan defaults hammered global banks and insurance giants financial markets were in a state of utter turmoil. Banks were terrified to lend money, even the best companies in the world were not able to easily raise capital and it lead to scary times.
Investment banks like Bear Stearns collapsed, AIA had to be bailed out by the American tax payer and the auto industry in the US required the same saviour. Locally, many of Australia’s biggest companies were in a similar boat.
So central banks did the only thing they could do, they started buying these toxic assets (think nuclear waste in the form of a loan) and lowering interest rates to stimulate the economy. Unprecedented economic policy such as negative interest rates and quantitative easing was used.
This was successful in enabling asset prices to recover and for companies to feel secure lending again. However, this has changed the world.
The unconventional monetary policy above has resulted in the value of growth assets such as stocks and real estate booming. For younger people like myself this is fantastic, for those in retirement it has bought on a new realm of challenges.
Gone are the days of getting a 5% return on a term deposit. Some of the older readers of this will remember the days of receiving a 15% interest rate on a savings account.
Today in Australia the average for a long term savings rate is 0.90% with many going as low as 0.10% or even 0% for on call accounts.
First and foremost the biggest issue is that in general we are living longer than at other time in the history of humanity. I’m no doctor but I am willing say it is a certainty that as modern medicine and scientific research continues to advance at an exponential rate we will continue to live longer and longer.
Secondly, is that as we live longer but continue to retire at the same age we are going to run out of money in retirement unless we invest significant portions of our income early, regularly and consistently.
Thirdly, is that in retirement we are not putting our work boots each morning, instead we rely on our investments to provide an income for us. However, when you are not working and contributing to your investments, investment losses hurt a lot more particularly when we need to draw down on our capital as well!
Fourthly, Australia simply does not have enough young people working to continue to fund a pension system for an ever growing class of retirees. Particularly when many hold multi million dollar assets that are not assessed for aged pension purposes.
For our youth not only are house prices at astronomical levels compared to a generation ago but they are also expected to pay for ever growing entitlements for others. Already things like university have gone from being government funded to being individually funded.
Throw in factors like wage stagnation and it is little wonder why for the avocado and toast generation travel and lifestyle are incredibly high on their priority list.
Fifthly, as interest rates have continued to drop investors seeking an income have moved more of their capital out of cash/fixed interest and moved into more aggressive/risky assets such as equity markets. This has been a smart decision over a 10 year long bull market but when the next crash happens (it will happen eventually, when exactly I have no idea) these investors may be in for a world of hurt.
Sixthly, governments are scared to announce changes to our current very generous and complex system because of voter backlash. Full disclosure, I was against Labor’s proposed Franking Credit policy but the truth is things need to change because it is simply not affordable over the long term. Unfortunately, it is going to take a heroic decision by a government to risk losing the next election in order to make the long term changes that will be necessary.
Seventh, as much as technology has changed the world and will continue to provide remarkable change for the world, we are going to see massive job losses across the world. Unless we are all going to become app developers or data analysts there is going to be a massive differential between the skills in the labour market and the demand.
I say the solution with a question mark because even as an expert in our retirement system this is a complex issue. These all are potential proposals that would help mitigate the future issues we will face:
1. Limit negative gearing to a total annual concession of $50,000 per individual
2. Removal of the aged pension for individuals with homes valued at $2.5 million and above.
3. Our education system needs to promote the skills of the future
4. Australia needs to promote immigration particularly to regional areas. More and more immigrants flock to Sydney and Melbourne, pushing up property prices and building population density that we are not prepared for. Australia is a huge country, lets use that space
5. Our youth need to be encouraged early to invest significant portions of their income into their retirement savings. There is a reason that many government departments routinely pay significantly more than the standard 9.5% superannuation. The lower the yield we can get, the higher the retirement balances need to be
6. We need to learn at a school how investment markets work and the importance of investing, superannuation and basic money management techniques.
7. Infrastructure spend needs to be at extremes during this period of super low interest rates. If we don’t use the opportunity to build schools, roads, hospitals, ports, aged care facilities at a low cost when we will. Secondly, this will create jobs.
8. Red Tape needs to be reduced. I’m not saying we should go back to the pre industrial revolution age of business policy but we do need to make Australia a transparent and straightforward process.
How I would Prepare If I Was Aiming To Retire In 2030
Knowing that my capital will be required to last a lot longer than in years gone by, the first thing that I would be looking to do would be to maximise my concessional contributions to my superannuation. The most significant reason to do so is to take advantage of the super low tax environment available within the superannuation environment.
Currently, an individual is able to contribute up to $25,000 a year which is taxed at the concessional rate of 15%. For an individual on our highest tax rate of 49%, this could be a tax saving of 34% on additional contributions! Full warning though, employer contributions do count towards this cap, so be careful not to exceed it.
The second thing I would be looking to do is pay down as much of my non tax deductible debt as possible. Every dollar you still owe when you retire, is a dollar that is not going to be compounding for you for the rest of your life.
The third thing I would look to do is ensure that my investment portfolio has an appropriate level of risk for my long term goals and that I am not paying excessive investment fees. Holding exposure to Australian and International shares will carry some short term risk but the bigger risk for many retirees is out living their money.
Personally, I am a big fan of direct share ownership and the ability to make investments that appeal to me. However, for the investor who is less knowledgeable about equity valuation engaging a professional can help you make intelligent market decisions or if that doesn’t appeal to you, Exchange Traded Funds (ETF’s) will enable you own a diversified portfolio at a very low ongoing cost.
The last thing I would do, is sit down and have a serious conversation about what my plan(s) for retirement are. The more extravagant my retirement plans, the more capital and income I am going to need to have available to fund my lifestyle.
I hope you had as much fun reading this, as I had writing it.
The information contained in this article has been provided as general advice only. The contents have been prepared without taking account of your personal objectives, financial situation or needs. You should, before you make any decision regarding any information, strategies or products mentioned in this article, consult your own financial advisor to consider whether that is appropriate having regard to your own objectives, financial situation and needs.