Eureka's Week: Retirement aspirations, bonds, yields, DIY fund returns

Eureka's Week

Robert Gottliebsen

Last night the US released the first estimate of the June quarter GDP. It was a big disappointment. Expectations were for a seasonally adjusted annual growth rate of 2.6% but the real figure came in at 1.2%.

This weakens the case for the Federal Reserve to start lifting rates and will also disappoint Australia's Reserve Bank. A strong US GDP figure would have offered a chance for a potential rate cut on Tuesday to deliver a healthy fall in the Australian dollar. As it stands, the US is likely to delay a rate increase, which will weaken the US dollar and reduce the impact of a rate cut here.

Still, with a fall in investment offset by strong consumer spending, up 4.2%, low unemployment and the risk of deflation receding, the US may get a chance to raise rates later in the year or early next. The US isn't as weak as the figure suggests and the markets seems to see it that way with the S&P 500 index closing near its all-time high.

Taking your super to the next level

There aren't many good features about the proposed superannuation changes that the Turnbull/Morrison Government plan to inflict on the retirement community. And as I pointed out last week, exactly what the final rules will be will depend on the Senate and, in turn, Bill Shorten.

But there is one small advantage in the whole grubby business - it provides a reason for all those operating self-managed superannuation funds, or relying on the large pooled APRA funds, to look at their overall position, particularly if people are in retirement or approaching it.

This week the SMSF Association (SMSFA) made public research on just where self-managed funds were standing. I am not going to go through all the detail because the conclusions of this survey will naturally apply to Eureka readers in a different ways, depending on their circumstances.

So I have attached the survey to my weekend commentary and I suggest you check it out and use the material to help you make an accurate assessment as to where you stand - you can read a copy by clicking here. But there are some important milestones that I would like to highlight for you - I certainly found them useful in assessing where I stand.

The SMSFA discusses three levels of pensions from superannuation funds - the SMSFA "comfortable" rate of pension is $58,922 per annum; a SMSFA "typical" pension is $70,000 per annum and the "aspiration" pension is $100,000 per annum.

So the first step is to look at where you stand among those three pension levels and whether you have the funds to be able move up the ladder. As we all know, the amount of money required to fund a pension is a function of how long retirees live.

Any estimate any of us make has an element of speculation as to how long you and your spouse will live. But if you are a couple aged 65 and in, or about to go into, retirement and are looking for a $58,922 pension per annum, then according to SMSFA you need approximately $702,000 in savings.

The amount of SMSFs who are unable to afford that $58,922 has gone up from 25 per cent to 30 per cent, so almost a third of self-managed funds where beneficiaries are aged 65 don't have sufficient money in them to be able to afford a $58,922 pension.

Now, if you aspire to a $100,000 pension per annum then the amount required for a couple aged 65 has gone up from $1,759,000 to $1,886,000. Unfortunately, the number of funds able to afford paying a pension at that level has fallen from 34 per cent to 29 per cent. There are lots of figures and graphs in the survey that will help you assess your own situation.

I realise that many Eureka readers do not have anything like that sort of money in their superannuation fund. Many have money or future income outside superannuation that now looks likely to be excluded. We are seeing rough retrospective legislation. The Senate may make the legislation fairer and we will wait and hope for that. Meanwhile it's not the end of the world - one of our tasks at Eureka into the future will be look at other ways to prepare for retirement.

Meanwhile, two revelations struck me. First, a significant number of SMSFs are paying pensions at a rate that is higher than their asset base justifies. That means that unless they have an early death there will not be sufficient funds to maintain the current level of pension in later years.

Secondly, a number of people are paying themselves pensions at a level that is lower than their asset base warrants. They could increase their standard of living. So Eureka readers need to look hard at just where they stand in the pension asset game. The report helps by using graphs that explain the assets required if you retire much earlier than 65.

Of course, the dreadful part of the government superannuation changes is that if you don't have sufficient funds already in superannuation, and are still working, it is now extremely difficult to put sufficient money into superannuation. This is very tough on working women who interrupted their careers to look after the children. A large number of people have already contributed $500,000, tax paid, to their fund so if the legislation goes through as envisaged by the Coalition they will simply not be able to get the high levels required into their fund. What the Coalition has done is to convert superannuation from a savings mechanism to provide a comfortable retirement lifestyle to one that provides far less retirement benefit.

That means younger Eureka readers will have to use other mechanisms to save. I was very blessed in being able to save via superannuation when the rules were very different but my children and grandchildren will not have that advantage.

In terms of the 2015-16 returns on superannuation the median performance of SMSFs was 4.2 per cent although obviously there were wide variations. Overall, 4.2 per cent was not a bad performance in the volatile sharemarket we have experienced.

If you take the 2015-16 underlying inflation rate at 1.5 per cent then the 4.2 per cent mean, that represents an inflation adjusted return of 2.7 per cent which is not a bad performance especially as many funds in pension mode carry higher cash balances because of the need to pay pensions each month. (The returns on those cash balances have been decimated.)

For those in their 60s, it is now not easy to establish a new savings vehicle. But for younger people you will need to look carefully at your long term situation, assuming that the legislation passed by the Senate means you can no longer get sufficient money into superannuation. Every real estate agent you run into tells you that the best way for younger people to save is to negatively gear a residential property. It certainly has been a brilliant exercise in the last two or three years in Melbourne and Sydney because interest rates have fallen while property prices have increased. But the returns in other centres have not been as good and we are now seeing a fall in rental income.

Accordingly there is certainly a greater degree of risk in negative gearing moving forward. One of the securities that younger people should think about is insurance bonds. Insurance bonds carry a tax rate of 30 per cent over 10 years but then are tax free. They also have a string of other advantages. While they are not as good as the old superannuation they clearly have tax advantages for higher income earners because they limit your tax bills. If you are on a low income then they have much less attraction. They are not a security for everyone but are certainly worth younger, high income savers looking at. And they can also be very attractive in estate planning to help grandchildren.

Meanwhile, those people that have their superannuation in the big funds are learning that some of these funds are "off to the races" and are gambling on negative yield bonds - bonds where you pay governments or companies to hold your money. Some of these big funds are using their members' funds to buy such bonds in the expectation that the level of negative yield will increase so there will be a capital profit. It is not a strategy that I would recommend. But it is a reminder of the fact that savers in other countries have a much bigger task to gain a return than those in Australia. Below is a graph that shows countries with negative yields:


The number of countries with negative yields is increasing. In my view it is central bank madness because it reduces the strength of their banks.

And on the subject of interest rates if we have an inflation rate of 1.5 per cent then a bank deposit at, say, 3 per cent is in fact a real rate of return of 1.5 per cent - which in former years would have been seen as satisfactory. During the week I was offered Rabobank hybrids at 4 per cent. I think I would prefer the bank deposits at 3.3 per cent that I described last week, if they are still around after the Reserve Bank meeting on Tuesday. If you are paying a home mortgage rate of 4.5 per cent then that rate is 3 per cent above the inflation rate, which is a high rate of interest although it looks low.

Now of course while house prices are rising higher than the rate of inflation rates look low. If house prices merely rise at the rate of inflation then house mortgage rates are high. I am not going to get into the game predicting what the Reserve Bank will do on Tuesday except to say that when you look at the table above our rates are very high and that is boosting the Australian dollar. Our central bank would be taking quite a risk leaving rates at high levels on a global comparison because a high dollar if maintained for a long time will affect employment.

Readings & viewings

The Trump-Putin fallacy. This NY Books article points out - frighteningly - that Trump is an all-American phenomenon.

This week's entries to The Atlantic's Donald Trump time capsule: the IRS says he can release his tax information, even though he insists a current audit is stopping him from doing so.

Using the leaked Democrat Party emails from Wikileaks, Matt Taibbi tells the story of how the party favoured Clinton over Sanders during the primary season.

Four qualities that helped small business survive the end of the mining boom.

It isn't just Australia struggling to end its coal addiction. Asia is too.

How can a country have almost 20,000 active fund managers and still deliver above market returns? It can't, argues Moody's (via the FT), which is why the US mutual funds industry should shrink or switch into low cost passive funds.

Ex-Fairfax journo Michael West explains why gas prices have gone through the roof, except for the Japanese.

If you're not one of the 35 million people that hasn't yet seen Carpool Karaoke with Michelle Obama, clearly a massive Stevie Wonder fan, here it is.

Former Governor of the Bank of England Merv King ruminates on the political fissures behind Brexit and how politics must change to address it.

Is voting with your heart immoral?

Jackie Chan gives the NSW government a boost.

Inside the world of artificial intelligence in sport: including robot rent-a-crowds to boost player morale.

Breaking down Marissa Mayer's payout after the sale of Yahoo to Verizon - it could be well above the $US55 million estimated.

Watch David Lynch explain the source of great creativity.

Mitchell Sneddon's recipe of the week: "It's another winter warmer: the original recipe for spaghetti bolognese as registered with the Bologna Chamber of Commerce...for those putting a tin of crushed tomatoes in you've been doing it all wrong. It's about the milk! Advisable is to gradually add close to a litre of milk over the course of two hours."

Happy 30th birthday to A-league soccer star Besart Barisha, who was born in Albania. Here's the Melbourne Victory striker's 2015-16 highlights.

To read this week's PDF, click here.

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