Probably the most important question when it comes to whether you have enough in savings to retire is what level of cash flow will you need through your retirement years.  For many this is a difficult question to answer.  However there are some tools to help in determining what this magic number might be.

1) A percentage of pre-retirement income

One rule of thumb is to look at your pre-retirement cash flow (spending) and estimate that this will reduce to approximately 70% to 80% of that level once in retirement.  So if you are spending at the rate of $100,000 you might estimate an $80,000 annual base spend through your retirement years.

Why might spending be lower in retirement?

The school of thought is that certain expenses will no longer be required or at least reduced especially in relation to work related expenditure.  Items such as transport to and from work, spending on work clothes and income protection insurance are a few of the costs that might disappear.

However there are also going to be costs to fill in the time that you now have available to you.

2) Create a budget

This is a really good exercise for anyone but particularly those preparing for retirement.  If nothing else the process should help identify what you are currently spending funds on and what you would like to be spending those funds on.  This exercise might actually shine a light not only on the financial implications regarding retirement but also how you intend on spending your time during those years.

A useful tool to get the buget started is through the ASIC Money Smart site's Budget Planner - https://www.moneysmart.gov.au/tools-and-resources/calculators-and-apps/budget-planner

Unfortunately many find this exercise difficult so there is a third option that might not only help develop your personal budget but also shine a light on whether your spending plans are in the right ballpark.

3) Refer to ASFA’s Retirement Standard

Even if you are comfortable using one of the above methods you might well ask – but is my current spending pattern / budget realistic or indeed efficient?

This is where ASFA’s Retirement Standard may be a useful reference.  The Retirement Standard sets out the budget for a modest and comfortable lifestyle for a single and couple.  The numbers are updated every quarter to take into account price movements (inflation).

The current numbers as at the end of September 2015 were:

So for a comfortable lifestyle in retirement for a couple aged approximately 65 the budget is just under $59,000.

The bottom line annual amount provides a simple number to focus your attention.  However, included with the bottom line amount is a budget that sets out how these broad brush figures were generated.

To find the detailed budgets take a look at http://www.superannuation.asn.au/resources/retirement-standard

Concluding Comments

I would encourage those preparing for retirement, as well as those already in retirement but wanting to review cash flow requirements, to reflect on the budgets set out in the Retirement Standard.  Everyone’s budget will be unique but this resource provides a useful starting point for those seeking greater clarity.

Regards,

Scott

The first budget for the new coalition government has as expected provided some significant changes as well as confirming changes that had been widely anticipated.   This summary will look at the following major changes grouped into three main areas – tax planning, retirement planning and government benefit planning.  The full summary can be found at our 2014 Budget - Personal Finance Summary page.

It has been a number of months since we updated the website with Scott Francis' articles published in the Eureka report.  We have now caught up and welcome you to take a look at these pieces - 17 in total.

For many years I have followed the writings and podcasts of Paul Merriman, a financial adviser based in the USA.  Recently Merriman has retired but continues to write and publish on financial advice particularly investment advice topics.  In a recent article 10 do's and don'ts for retirement investors he looks at 5 key dos and 5 key dont's in retireement.  Even though the comments are focussed on retirees in the US the broad concepts are just as relevent for us here in Australia.  So here are the 10 items for your consideration:

Retirement do’s

1. Do take advantage of “the only free lunch on Wall Street” by building a diversified portfolio of mutual funds (managed funds in Australia). This will reduce your risk and probably increase your returns.

2. Do buy funds with the lowest possible expenses. The average equity fund charges more than 1.3% a year, yet you can get most of the asset classes you need in good funds for a full percentage point less than that. This is equally important for bond funds.

3. Do buy index funds instead of actively managed ones. This will be a big help in achieving both of the prior “do’s” I mentioned.

4. Do invest in equity asset classes with long histories of successful returns. Based on years of careful study by academics I trust, this means U.S. large-cap blend, U.S. large-cap value, U.S. small-cap, U.S. small-cap value, international large-cap blend, international large-cap value, international small-cap blend, international small-cap value, and emerging markets. And for tax-deferred accounts only, it means U.S. REITs. (In Australia the asset classes include Australian large-cap companies, Australian value style companies, Australian small-cap companies, International large/value/small cap companies, emerging markets and Australian and international REITs)

5. Do invest in the most tax-efficient manner. Unless you have unusual circumstances, that means maximizing your IRA and 401(k) accounts and (when you’re living off your money in retirement) using up your taxable accounts first. (In the Australian context this is about effectively utilising superannuation and superannuation pension accounts)

Retirement don’ts

1. Don’t pay a sales commission to buy or sell a mutual fund. The commission is money that’s gone forever from your nest egg, and it inevitably and permanently diminishes the return you will get. (In Australia you can no longer buy funds that have commissions attached but any existing managed funds may still maintain a commission structure.)

2. Don’t buy funds in asset classes with low expected returns or high levels of risk relative to their expected returns. Among the most prominent examples of asset classes you should avoid are commodities, gold and technology stocks. In addition, I think you should steer clear of pure growth funds, whether they invest in large-cap, midcap or small-cap stocks — and this includes international funds as well as U.S. funds.

3. No matter how much you are attracted to an active manager, don’t buy actively managed funds. This is really another way of stating my third point above. Actively managed funds are guaranteed to have higher expenses than index funds, and their returns aren’t likely to be as high as those of index funds.

4. Don’t speculate with your portfolio, even a small part of it “for fun.” If you have a properly diversified portfolio along the lines that I recommend, your investments will include all the “great opportunities” you will ever need. Speculating and playing the market will almost surely reduce your long-term returns. 
   
   If you absolutely can’t resist trying your luck, then spend (notice I am not saying “invest”) a bit of money that you can afford to lose and buy a lottery ticket.

5. Don’t get snookered into thinking you have found a guru or anybody else who knows what will happen to the market in the future beyond statements such as “Stocks will go up in the long run.” Many people claim to have that knowledge, but nobody does. The sooner you can accept this fact the sooner you will be in touch with reality. 
   
   When you are in touch with reality, you are likely to invest more intelligently and productively.

These are great insights from a man with many more years of experience than me and well worth consideration for you investment portfolio.

Regards,

Scott

The Association of Superannuation Funds of Australia (ASFA) has just released new data regarding indicative costs in retirement relating to the period ending 31^st of March 2013.  The media release suggests that health and energy costs rose over the March quarter whilst food and leisure goods and services fell.

I believe the information provided by ASFA can be useful in 2 key ways:

- assisting clients to determine what their budget should be when reaching retirement
- providing a gauge of inflation for those preparing for or in retirement

The study includes indicative budgets for 4 groups as follows:

A single person with a modest lifestyle                $22,641
A single person with a comfortable lifestyle         $41,169
A couple with a modest lifestyle                         $32,603
A couple with a comfortable lifestyle                  $56,317

When using the breakdown of budgets provided care should be taken in seeing whether they fit your requirements.

In terms of inflation the latest data suggests there has been only slight changes with the two comfortable lifestyle budgets actually falling slightly.  However the annual change was between 2.16% and 3.17% due to a large jump in costs in the September quarter of 2012.

This inflation data can be really useful for assisting with determining what level of total return will be required to meet the goal of making sure assets last long enough through retirement years.

Using this data you can add a required drawdown rate - say 5% - and add the level of fees you are paying - say 1.25% - to work out what you need your portfolio to be generating in total returns - 9.25% using the example data.

This can then be a really useful starting point to see what style of portfolio you require to reach that total return target.  In particular how much risk needs to be incorporated into a portfolio.  In particular, if you are targetting a 9.25% total return, you should be considering what style of portfolio has provided that return through history with the least amount of volatility (risk).

For anyone contemplating or in retirement taking a look at the ASFA Retirement Standard data could be a really valuable use of time and a great starting point for retirement planning.

Regards,
Scott

A key issue when analysing whether you have enough invested to retire is how much you expect costs of living to increase by through your years of retirement.

This is a tough number to determine.   Many economists have trouble enough identifying what it has been historically yet alone trying to predict what it might be for the next 20 or 40 years.

Using history as a gauge

Economists tend to start their analysis using the Consumer Price Index (CPI).  In Australia the Australian Bureau of Statistics  (ABS) has the responsibility of determining this index level every quarter using a pre-defined basket of goods.  It calculates the cost of that basket of goods and compares this with previous levels to calculate how much prices have changed.

The database I looked at placed the CPI at a rate of 5.27% since October 1948.    However this period was marked by extremely high inflation through the 70s, 80s & early 90s.  (Inflation was close to 10% on average from the beginning of 1973 until the end of the 80s) Since then central banks and governments around the world have implemented inflation targeting as a core economic policy and through doing so have driven inflation down. (It has averaged 2.7% from the beginning of 1990 until the end of March 2013 in Australia.)

In Australia the Reserve Bank of Australia target rate of inflation is somewhere between 2 and 3% over the course of the economic cycle. Hopefully a firm lid can be kept on inflation so that it will not climb back to the levels experienced in the 70s and 80s.

What is current level of inflation?

The most recent reading of the Consumer Price index suggests that the cost of living rose by 2.5% for the 12 months to the end of March 2013.

Some commentators suggest that the basket of goods used by the Australian Bureau of Statistic might not provide an accurate reading of cost rises for retirees.  I also look at 2 other measures to see how costs are faring for retirees:

1) The ASFA Retirement Standard
2) The Australian Bureau of Statistics Selected Living Cost Indexes

ASFA Retirement Standard

Every quarter the Association of Superannuation Funds of Australia (ASFA) commission a report conducted by Westpac to gauge the cost of living in retirement for singles or couples with a modest or comfortable lifestyle.

Figures to the end of December 2012 suggest that costs have risen by:

2.99%  for a single person with a modest lifestyle

1.93%  for a single person with a comfortable lifestyle

2.78%  for a couple with a modest lifestyle

1.97%  for a couple with a comfortable lifestyle

For me this suggests that cost s for those in retirement are rising basically in line with the official CPI figures and with in the Reserve Bank target.

The Australian Bureau of Statistics Selected Living Cost Indexes

The ABS has started to release living cost indexes on a quarterly basis for a number of broad groups.  The latest data release for the period ending March 2013 suggests the annual increase in costs have been:

2.7%  Pensioners & Beneficiaries
2.8%  Age Pensioners
2.3%  Self Funded Retirees

So again these numbers fall close to the broad CPI figure and with the Reserve Bank’s 2 to 3% target.

So what level of inflation should be used for predictive purposes?

My approach is to start with the current rates of inflation.  If these levels are below the 3% Reserve Bank threshold  (which they currently are) I would use 3% .  If they are above the 3% threshold I would tend to use the current levels.  i.e. I try to use the worse rate to hopefully build in a level of conservatism.

If you are an inflation bear, you might want to use a rate more like 5% on average.

If you can use a higher level of inflation and still meet your retirement goals all the better.

But how will investments respond in different inflationary environments?

A final aspect to consider is how might investment returns behave in various inflationary environments?

Historically, over the long term, returns on asset classes tend to be within percentage bandwidths from the prevailing level of inflation.  For example an oft-used rule of thumb is that shares should provide a return of 6 to 7% above inflation.

The real art is to make sure that your investment mix  has enough exposure to investments that tend to perform better in inflationary periods.

Unfortunately there is not enough time to go into details now but I will come back to it in another day.

Regards,
Scott

No matter what your opinion is on where investment markets will go next, one area of agreement is that markets have been volatile in recent years.   Nobel Prize Winner – William Sharpe – has recently provided his thoughts on investing in a turbulent market for the Stanford Graduate School of Business where he is a professor emeritus of finance - William Sharpe: How to Invest In a Turbulent Market

We think highly of Sharpe’s work and it forms a major part of the investment philosophy we use to develop investment portfolios for clients.

So has Sharpe’s views changed since the GFC started in late 2007?  In a word, NO.

In the Stanford article Sharpe provides an overview of his four pillars of investing - Diversify, economize, personalize, and contextualize.

In a nutshell these pillars are:

Diversify – invest in a broad range of shares and bonds – preferably all of them.

Economize – keep costs low.

Personalize – make invest decisions that are most appropriate for your own situation.

Contextualize – the price of an investment reflects the average opinion of investors about its future.  You may think your opinion is superior, but it pays to be humble, investing in the market rather than trying to beat it.

Sharpe provides some really important concepts that in our opinion should be the basis for developing a successful investment philosophy.

Regards,
Scott

However, a major issue I have with the “Big Bucket” investment approach offered by these and other superannuation offerings comes to when you want to start drawing down on the balance to sustain your cost of living and lifestyle in retirement.

By Big Bucket approach I mean whereby you have a range of investment choices which hold a diversified pool of assets and you get to choose one or two of these choices.

The problem comes once you start to draw down.  A few years ago you did not have the choice of targeting where to draw your payments from so you were forced into selling down a percentage of all the asset classes held in the fund.  This thankfully has improved so now a member could have a cash option and draw all payments from there along with a balanced, moderate or conservative diversified option.

So a suggested structure within these big bucket fund is to have a holding of cash alongside a diversified investment option matching your required asset allocation.

This all sounds pretty reasonable.  The problem in the structure is that the investment earnings generated by a particular investment option are not able to be directed back into the cash option to top it up.  Rather they get automatically re-invested back into the investment choice from which they were generated.  The end result is that you quickly see the cash component dwindle.

So what this means is that a member has to manually sell down assets from the diversified balanced, moderate or conservative option to top up the cash account.  What you are doing is selling a range of asset classes.  This includes selling down growth style assets such as shares and property.

If those investments have been steadily growing this is not a problem as we would be undertaking effective rebalancing.  Unfortunately when growth asset markets are struggling, selling down these assets is locking in the losses or poor performance that has occurred.

Take the past 5 years as an example.  We are still well away from seeing shares and listed property assets regaining the levels of late 2007.  If we are forced sellers now we are locking those paper losses into real losses.

In my opinion a much more effective arrangement is to take control of where the income generated by assets is invested and in doing so reducing the need to be forced sellers of assets at a point in time.

Another interesting side issue is to know where administrative fees are being taken from in “Big bucket” accounts.  Most likely it is across the investments proportionately.  Here is another situation when you can become forced sellers when ideally it would be better not to do so.

At A Clear Direction we believe that you can have the benefits of a low cost superannuation service along with the necessary control to make sure you are not forced into making poor investment decisions along the way. 

In the present political climate it is easy to get caught up in the debate over whether it is the right time for the government to be moving to a fiscal surplus.  Rather than focus on the politics of the Budget, we think it is best to focus onthe practical implications and look at how changes impact on individual financial planning strategies.

The budget has provided a number of significant changes impacting on financial planning strategies.  These have been outlined in this summary.  The major changes include:

• Deferral of higher concessional contributions cap for individuals aged 50 and over from 1 July 2012
• Higher tax on concessional contributions for very high income earners from 1 July 2012
• Mature age worker tax offset (MAWTO) to be phased out from 1 July 2012
• Increased Medicare levy low income thresholds from 1 July 2011
• Means testing of net medical expenses tax offset (NMETO) from 1 July 2012
• FTB Part A increase
• Family Tax Benefit (FTB) A eligibility from January 2013
• Supplementary Allowance
• Schoolkids Bonus
• Aged care reform from 1 July 2014
• Accelerated real estate review from 1 July 2012
• Reduced payment period of Australian Government Payments for people who are temporarily absent from Australia from 1 January 2013
• Australian residency requirements for the Age Pension from 1 January 2014
• Removal of the capital gains tax discount for non-residents
• Changes to tax rates for non-residents
• Company Loss Carry Back
• Small Business Immediate Write-Off Extension
• Previous proposals shelved
  • Reduction of the corporate tax rate to 28%. The corporate tax rate will remain at 30%.
  • Standard tax deduction of $1,000 for work-related expenses and the cost of managing tax affairs.
  • 50% discount for the first $1,000 of interest income.

The following changes announced since last year’s budget have also been confirmed

• Confirmation of changes to marginal income tax rates & thresholds
• The minimum draw down relief for superannuation pension holders will be extended next year with minimums being 75% of the original rules and returning to the normal rates from July 1 2013.
• Changes to co-contribution arrangements
• Superannuation guarantee rate to progressively rise from 9% to 12%
• Maximum age limit for the superannuation guarantee to be abolished
• Low income superannuation boost
• Allowances & supplements  to reduce the impact of the introduction of a price on carbon

Each of the above items has been addressed in a little more detail our 2012 Budget - Personal Finance Summary.

The key strategy considerations stemming from these changes include:

• Those in the workforce who are 50 or older to reconsider salary sacrifice strategies to ensure that concessional contributions in excess of $25,000 are not made and how to be prepare to make the most of increased contribution thresholds come July 2014.
• Those earning more than $300,000 of income to consider whether superannuation contributions need to be lifted to replace the extra tax payable on concessional contributions.
• Non-residents to take extra care in the disposal of assets with realisable capital gains.
• Salary sacrifice strategies to be re-assessed under the new marginal tax threshold levels and rates.
• Personal superannuation contributions in order to access the government co-contribution need to be re-assessed in light of the changed thresholds and rate.
• Those turning 70 to consider the benefits of the continued superannuation guarantee contributions.
• Continued consideration of pension payment draw downs if looking to draw only the minimum allowed.
• Small business owners to consider the timing of discretionary capital purchases.

I have just sat down to a cup of coffee at Starbucks and began reading through some reports I downloaded over recent months.

I found HSBC’s The Future of Retirement Why family matters report very interesting especially as it looked at surveys conducted with 17,000 people across 17 countries but not Australia.  As I read I pondered whether the findings were relevant to Australian families and quickly came to the conclusion that the vast majority of findings would probably be consistent with responses from Australians.

The key findings for me were:

-       65% of men said that they make all or most of the financial decisions in the house without any input from others, compared to just 53% of women who said that they were the sole decision-maker.  This gender gap is apparent across all age groups.

-       The only area where women are more likely to be the sole decision-maker is in household budgeting. Even here, the gender gap disappears among those in their thirties, with younger men taking a stronger interest in this aspect of financial planning than older men.

-       Significantly, women are far more likely to stop working full-time when they have children (47%), compared to just 1-in-6 (15%) men. The onset of parenthood not only reduces women’s role in the workplace, it also reduces their role in making financial decisions in the home. When looking at financial decision-making, the gender gap is greatest among men and women who have children.

-       A major gender gap exists in financial planning: only 44% of women stated that they had a financial plan in place for their own or their family’s future, compared to 54% of men.

-       Married people plan ahead in greater numbers and experience a smaller gender gap when looking at who exercises financial responsibility – 55% of married women and 62% of married men have made a financial plan.

-       In spite of the changing financial needs throughout people’s lives, 60% of respondents have never sought professional financial advice to help them, relying instead on their own knowledge or that of friends and family.

-       The majority of households have a predominantly risk-averse attitude, and are more likely to forego the benefits of long-term investing in favour of security in the short term. This view is particularly prominent among women especially in Western countries.

-       (Somewhat surprisingly) Only 13% of men and 18% of women thought that investing in stocks and shares was extremely risky.

From their findings, the writers suggest 4 key points of action households can implement to improve future financial well being :

1. Share decision-making. It is important that household financial planning is shared and takes into account the family unit and the potential financial needs of spouses, children and any other dependent relatives.

2. Review financial plans in light of major life events. Financial planning should not be static. Family events like births, deaths and marriages should act as triggers to start or review the family’s financial arrangements.

3. Sense-check decisions with a professional financial adviser. Even where plans are put in place, they will contain gaps. Seeking professional advice can help to identify and plug any gaps that might arise.

4. Take a balanced approach to managing investment risk. Households should balance the need to protect their investments in the short and medium term with the need to generate an adequate retirement income in the long term.

These are pretty common sense steps for households.  If you would like to discuss details further or engage an adviser to work with you on securing your future financial well being please do not hesitate to get in cotact. 

Regards,
Scott