After several years in their bunkers, Australian investors are beginning to look beyond the safe haven of cash in the search for better returns. Shares have started the year with strong gains, the residential property market is showing signs of recovery and superannuation fund returns are the healthiest in years.
Suddenly, growth is back on the agenda and it is not hard to see why. Interest rates for bank term deposits have fallen below 4 per cent, less than the dividend yield on bank shares. And unlike shares and property, bank deposits offer little opportunity for capital growth.
Experienced investors know that long-term wealth accumulation depends on total investment returns from income and capital gains to keep ahead of inflation.
Over the past 20 years, shares and residential property have provided a total return of about 9 per cent a year1. Roughly two-thirds of that return comes from capital gains, but the income from quality shares and property also rises over time. By comparison, interest rates on term deposits fluctuate depending on the interest rate cycle.
Time to think long-term
Now that the pendulum is swinging back towards growth, it is a good time to check whether your investments are on track to deliver the returns you need to reach your long-term savings and lifestyle goals. The place to start is at the finish line.
No matter what your age or stage of life, the ultimate goal is a long and comfortable retirement and that takes some planning. Everyone’s aspirations and circumstances in retirement will be different. First you need to think about the lifestyle you hope to lead in retirement and what that would cost.
As a general rule-of-thumb, advisers suggest you will need about 65 per cent of your pre-retirement income to maintain your current standard of living in retirement, assuming you retire at age 65.
As a starting point, the Association of Superannuation Funds of Australia (ASFA) estimates that a single retiree needs $41,000 a year and a couple needs $56,000 a year to lead an active and comfortable lifestyle2. This includes things such as private health insurance, a reasonable car, domestic travel and the occasional overseas trip. A more modest lifestyle costs less, but more than the Age Pension currently provides.
The next step is to work out the savings needed to achieve your goal. Most people focus on the amount they need to accumulate by the time they retire, but that is only part of the equation. The retirement lump sum you need to aim for will depend in part on the return you earn on your savings after you retire.
Growth boosts retirement income
Take the example of a single person retiring at age 65 and aiming for a comfortable lifestyle on $41,000 a year. If their savings are invested for a return of 5 per cent a year in retirement they will need a lump sum of $765,000; but if they earn a 7 per cent return they will need only $630,000. The lump sum required by a couple aiming for $56,000 a year would be $1 million with a 5 per cent return and $865,000 with a 7 per cent return.
In other words, if you invest your entire nest egg in conservative cash and fixed interest investments you will need a much larger lump sum on retirement than you would if you left some of your money in growth investments such as shares and property. Either that, or resign yourself to living on less.
A question of balance
While it is prudent to reduce exposure to higher-risk growth assets as you near retirement, that does not mean excluding them entirely. Getting the mix right is a balancing act. Your adviser will be able to help you work out the best mix of growth and income investments to fit your life stage and risk tolerance.
According to the Australian Bureau of Statistics, the average 65-year-old Australian can expect to live another 19 years if they are male and 22 years if they are female4. That is a long time to be living on your savings, especially when you consider that the average retirement age is actually closer to 55, not 655.
Saving for retirement does not stop at age 55 or 65, it is a life journey. By maintaining an appropriate balance of growth and income investments your savings will continue to work hard while you take it easy in retirement.
1 Russell Investments, ASX, Long-term Investing Report 2012, viewed 22 March 2013, http://www.russell.com/AU/_pdfs/market-reports/asx/ASX_Report_2012.pdf
2 ASFA Retirement Standard, February 2013, viewed 22 March, 2013, http://www.superannuation.asn.au/resources/retirement-standard
3 SuperGuide, viewed 22 March, 2013, http://www.superguide.com.au/how-super-works/a-comfortable-retirement-how-much-super-is-enough
4 ABS, viewed 22 March, 2013, http://www.abs.gov.au/ausstats/abs@.nsf/Lookup/4125.0main+features3110Jan%202013
5 ABS, viewed 22 March, 2013, http://www.abs.gov.au/ausstats/abs@.nsf/Latestproducts/6238.0Main%20Features3July%202010%20to%20June%202011?opendocument&tabname=Summary&prodno=6238.0&issue=July%202010%20to%20June%202011&num=&view