It’s a commonly held theory that investors saving for retirement should have a reasonable proportion of growth assets in their investment portfolio. This is, of course, dependent on a range of other factors, not least their appetite for risk.
Typically, as investors approach and enter retirement, their portfolios become more defensive and are focused on generating income. That makes sense. After all, once retired the need for investment income escalates and, as an investor’s ability to replace assets is diminished, risk aversion tends to increase.
However, given our propensity to live longer, should the traditional retirement investment model be revisited?
What are growth assets and why are they important?
Growth assets are the ‘engine room’ of an investment portfolio. They are designed to do the heavy lifting and provide the capital growth of that portfolio over time. Growth assets include shares, property and a range of alternative investments. Typically speaking, they:
- generate high levels of capital growth over the longer term
- deliver some income through dividends or annuity streams such as rental income
- deliver returns that beat inflation.
By contrast, income or defensive investments – such as cash and fixed income – generally provide a regular income with limited potential for capital growth.
While growth assets can be volatile over short periods of time, historically they have produced greater returns than defensive assets over five years or more.
The retirement savings gap
The retirement savings gap is a measure of the amount of money required for retirement compared to the amount of money available to fund that retirement. According to recent research undertaken by Rice Warner into the retirement savings gap in Australia*, a retirement savings gap of around A$727 billion was identified.
This equates to $67,000 per person less than the amount required for a ‘modest’ retirement standard, as measured by the Association of Superannuation Funds of Australia (ASFA). In other words, the $67,000 shortfall in savings means these retirees do not have sufficient retirement savings.
Better health, nutrition and focus on fitness means, generally speaking, we’re all living longer. But this also introduces longevity risk – the risk of a client outliving their retirement savings and having to rely solely on the Age Pension.
Rice Warner analysis suggests that the next 15 years will see more Australians leaving or winding down from the workforce than entering it. Australia’s ageing nation will comprise 2 million men and 2.3 million women in retirement drawing a pension from their superannuation savings by 2029. Rice Warner also expects that more than 50 percent of these retirees will outlive their retirement savings.
Growth assets and retirement
Everyone wants to live longer, but nobody wants to outlive their retirement savings. As a result, the traditional model that focuses primarily on defensive assets in retirement is coming under increased scrutiny.
Defensive, income generating assets generally have little capital growth potential. As income needs aren’t adequately met (in part, a result of the prevailing low interest rate environment) and as retirees live longer, capital drawdowns increase.
This has a two-fold effect. It reduces the capital value of the portfolio and the income that can be generated by that capital. This becomes a downward spiral – not enough income, withdraw more capital. Less capital means less income, withdraw more capital…and so it goes, until there is nothing left but the Age Pension.
It’s accepted that growth assets play an important role while saving for retirement. They can however, continue to work for investors during retirement. Maintaining exposure to equities, property and alternative investments can provide the growth required to counterbalance drawdowns from defensive assets and help people have a more comfortable retirement.
*Retirement Savings Gap research by Rice Warner; commissioned by the Financial Services Council, as at 30 June 2013.
