When it comes to investing for your retirement security, average returns are not good enough. Here’s why.
If someone asked ‘How are you?’ and you responded with ‘I’m feeling average’, the connotation is that you’re not feeling well.
When it comes to investing for your retirement security, the concept of average is commonly employed, but is that good enough? Individual investors rely on achieving long-term, average returns under the ‘traditional balanced approach’ used by many superannuation funds.
The truth is, as an individual either approaching or in retirement, you are unlikely to achieve a smooth return path of the assumed, long-term average return.
Five years prior, and five to ten years post your retirement from the workforce are referred to as ‘The Retirement Risk Zone’. During this time, individuals have a super balance as large as it’s ever going to be and face considerable risk to their retirement security from a sharp market downdraft.
The traditional balanced approach offers very little in the way of downside protection and in the way of differentiation between investments during the accumulation phase and retirement phase. It also has an overdependence on diversification benefits, and as previously mentioned, an implicit reliance on achieving long-term average returns.
At Clime, we don’t believe this traditional balanced approach is good enough for everyday investors seeking to achieve security in their retirement.
The retirement risk zone
The reason why the five years prior and five to ten years after retirement pose the greatest risk to retirement security is relatively straightforward. You are accumulating what will likely be the most savings you will ever have in your life to sustain retirement, and at the same time, your window for making regular contributions is growing shorter.
The risk posed to your retirement security from a major market drawdown during these periods is significant and needs to be managed. The following outlines what we view as limitations of the traditional balanced approach employed by the majority of superannuation funds, along with potential solutions we are either implementing now, or in the process of developing.
Limited downside protection
Relatively narrow asset class ranges and incremental asset allocation ‘tactical changes’ means a traditional balanced approach offers limited downside protection to investors.
Capital preservation is one of the foundations of long-term value investing. During times of increased uncertainty, there is a corresponding increase in the likelihood of capital loss from growth assets such as equities. We believe in a wider asset class range and undertake meaningful tactical changes in asset allocation. Equity risk can be more effectively managed to deliver a smoother return profile to investors.
Little differentiation between Accumulation and Retirement Phase Investors
While the mirroring of accumulation and retirement phase strategies is starting to change, traditional balanced approaches still offer little differentiation between the two. What this effectively says is a 25-year old accumulation phase investor has the investment needs and objectives equivalent to a 45-year old accumulation phase investor, and again to a 65-year old, or potentially even an 85-year old retirement phase investor. There is a considerable difference.
Clime is an objective-based investor and employs an objective-based approach which focuses on:
- Growing your retirement savings;
- Guarding your retirement savings along the way; and
- Generating meaningful retirement income.
In the investor phases above, there’s a clear difference in the likely weightings assigned to these three primary investment objectives.
Overdependence on diversification benefits
A traditional approach relies upon the long-term diversification attributes typically seen in a normal market environment . In more volatile market conditions, these long-term attributes offer far less in the way of diversification benefits. Correlations in highly uncertain market environments will tend to move towards +/-1. We have observed market participants becoming more short-term focused and in a risk on/risk off investing mindset. While holding in calmer market environments, long-term diversification attributes are far less dependable in times of elevated market volatility.
We are developing a framework of purposeful mandate design. Within this framework, each sub-portfolio has a specific role to play in achieving the investment objectives of the broader portfolio. Cash is maintained to preserve capital and as ‘dry powder’ to pursue selective opportunities across the portfolio.
Over-reliance On Achieving Long-Term Average Returns
Your retirement journey is very likely to be anything but average. Long-term results over twenty or even thirty years are insightful, however also contain an inherent sequencing risk. A series of strong negative returns achieved early in your accumulation phase saving cycle is far less detrimental to your retirement security than if equivalent strong negative returns were to occur within your ‘Retirement Risk Zone’. When it comes to your retirement journey, you only really get one chance to get it right. For those investors either approaching, or in retirement, we believe that the traditional balanced approach is not good enough for everyday investors seeking to achieve security in retirement.
Written by Anthony Golowenko, Head of Investments
 Normal market environment in this case refers to generally stable market conditions where volatility, and investor risk aversion are not elevated.
 Sequencing risk refers to the order in which returns are achieved.