Understanding life-cycle super products
Should I put my super into a life-cycle option?
If you haven't already heard of life-cycle or target-date investment options, get used to them.
They are increasingly popular both in Australia and overseas.
Statistics from the Australian Prudential Regulation Authority (APRA) show almost 30 MySuper funds have life-cycle investment strategies as their default option and a growing number of funds offer life-cycle investing as part of their investment menu.
How it works
Let's look at how these funds differ from the standard balanced option.
A balanced fund is a mix of growth assets such as shares and property and more conservative assets such as cash and bonds structured to give the best risk-return trade-off for the average member.
They can work well. The only problem is that not all of us are average.
Assuming that a 25-year-old starting on an upward career path needs the same investment strategy as a 64-year-old hoping to retire in the next 12 months can deliver outcomes fraught with difficulties.
Do you "cheat" the 25-year-old of potentially higher returns by having more conservative investments than they need, given that they probably won't retire for another 35 to 40 years and have plenty of time to ride out market downturns?
Or do you risk the 64-year-old's capital by holding a higher proportion of growth assets, despite the fact that they will be drawing down their super in the near future and won't be able to top it up if there is a market meltdown before then?
Life-cycle funds address this problem by rebalancing your asset exposure as you get older.
So the 25-year-old would have a high weighting to growth assets and as they get older the mix changes to become more conservative.
The Australian Securities and Investments Commission's MoneySmart website says a typical life-cycle investment mix would be:
- 85% growth assets if you are under 45.
- 75% growth if you are 45-54.
- 55% growth if you're 55-64.
- 40% if you're 65 or older.
While the terms are often used inter-changeably, there is a difference between life-cycle and target-date options.
Life-cycle investments are based on your age whereas in a target-date fund you should be able to nominate your retirement date and your investments will be managed towards that date.
This allows a little extra flexibility if you wish to retire early or late. In the US and Canada, funds are often constructed with specific target dates (such as 2025 or 2030) and investors pick those that best suits their plans.
Understand your options
Take care to understand exactly how a life-cycle or target-date option works. Know when rebalancing happens - is it automatic or is there some flexibility?
Are you comfortable with how your portfolio will change? Can you nominate your own retirement age or does the fund assume you'll retire at a certain age?
Pros and cons
One of the main drivers behind the popularity of these funds is timing risk.
While balanced funds may well provide a higher return on average over the longer term, an individual member might find a market downturn occurs at a point in their life when they can least afford it.
Just ask the many investors who had their retirement plans dashed by the GFC.
But critics point out that life-cycle strategies can lead to lower returns as your exposure to growth assets is highest when you are young (and presumably don't have much money in your fund) and lowest in the years before retirement when your account balance is much higher.
So you could miss out on earnings in those pre-retirement years.
As the Murray inquiry highlighted, the super system focuses on accumulating money for retirement. It doesn't address what will happen once we stop working.
Given that most of us will live into our 80s, setting an age such as 65 as an effective "cut-off date" may not be the best approach.
Research by Russell Investments has found that of every dollar drawn down in retirement, roughly 10c was originally saved, 30c came from investment returns earned before retirement and 60c came from investment returns earned while the investor was drawing down on their super.
So going too safe too early can also have a significant negative impact on long-term retirement plans.
The next generation of life-cycle funds is expected to be more customised, taking into account factors such as your account balance, marital status, income, non-super assets and desired retirement income as well as your age. But that's a while off yet.
Don't forget that you may have resources outside super
If you can work longer or have other investments, you may not need to protect your super to the same extent as someone who doesn't have these back-ups.
Decisions should take into account your full circumstances, not merely your super.
- OneLife-cycle investments reduce your exposure to growth assets as you get closer to retirement.
- These options reduce the risk of having your retirement plans scuppered by a major sharemarket fall just before you reach retirement.
- Investors still need to look at their full financial circumstances in choosing the most suitable fund.