The pros and cons of life-cycle investment funds
Ask curmudgeons nearing retirement what they want from their super and they'll unhesitatingly say they want high returns and low risk.
Life-cycle investment funds give you that - just not at the same time.
Life-cycle funds put you in high-growth, high-return investments up to about age 50 and then progressively drop to more conservative investments before retirement to preserve capital. They were introduced in the wake of the GFC, which had hit older fund members hardest.
Chant West director Warren Chant says the idea of a life-cycle fund is appealing.
"Generally there's a high percentage - 85% or more - invested in growth assets to start with and from age 47 it starts to decline on a regular basis by about 1% every six months. By the time someone retires there might be only 40% in growth assets."
"You'll recall those retirees in the news with awful stories about how they'd lost 60% of their super because they were in the equity market when it crashed. It gave rise to what we call 'sequencing risk'," says Alex Dunnin, executive director of research at Rainmaker SelectingSuper.
"It's a bit of a wanky term and if you are younger and the market crashes you can recover from it. But if you are going to retire next week and the market crashes today you say, 'Jesus, I thought I was going to walk out of here with $500,000 and I've only got $350,000!'
"So life-cyle products were introduced as a way to say, 'Look, as you are getting a bit older, what about we dial down the growth assets in your portfolio so that if the market does crash, it won't hit you as much?' " Dunnin says there are about 4 million accounts in life-stage products.
"The life-stage market represents about a third of all the dollars in MySuper so it's becoming very big, very quickly," he says.
There is a cost, says Dunnin.
"People get the benefit of compound interest as they get older, when they've got big amounts of money in their super. So just as you are building up these big balances, you push money into lower-performing investments. So the compound interest kick of the last 15 years of working life is lost.
"You are really saying you are prepared to sacrifice that money in order to have less risk and less to worry about. Equity markets have a habit of bouncing back, so if you're putting your money into life-stage investing, you're effectively banking on a long-term recession ... if the market doesn't crash, you've made a poor decision."
For a person retiring at 65 or 67, of each dollar spent during retirement, 60c comes from earnings in retirement, 30c is earnt before retirement and 10c comes from pre-retirement contributions, says Chant.
"If you said to a 65-old-year, 'For the rest of your life ... of every $1 you spend 60% of it will be based on earnings from now on,' they might say, 'Maybe I should take a little more risk'."
Chant says people forget to factor in the age pension.
"You could say the age pension is an inflation-linked, government-guaranteed annuity. People retiring now have $100,000 to $200,000. Theoretically, the pension's value is about $400,000 - for many people about two-thirds of their portfolio. So for the other third, you don't need to be invested conservatively. You can take a bit more risk."