With Australian interest rates hitting all-time lows, dividing up the asset pie has never been more important. Asset allocation, as part of a well-designed investment strategy, can help retirees to generate income as they balance risk and return.
Let’s look at the numbers. For a minute, imagine you have amassed $2,000,000 to provide for your retirement. You decide that you don’t want to take on much risk, so you seek out an investment that will provide security of capital. As a result, in exchange for your $2,000,000 investment, you receive the grand total of $29,000 annual income.
This is around $7,000 per annum less than the full rate of the age pension for a couple, and $11,000 less than the amount The Association of Superannuation Funds of Australia (ASFA) suggests provides a modest retirement income! Although this sounds ludicrous, for many Australian retirees, this is the reality.
At the time of writing this article, the official cash rate sits at 0.75% and many pundits are suggesting another drop is possible in February 2020. As a result, term deposit rates are commonly less than 1.5% for 12 months. This is even below the annual inflation rate of 1.9%, meaning that if you are holding cash, you are effectively going backwards.
The only solution therefore is to take on some investment risk. Assets with returns higher than cash, such as bonds, shares and property are needed to fund a retirement. This does come with extra risk though, so getting the right balance of risk and return is essential.
A good strategy should balance the return you need to reach your goals, the level of risk you are comfortable with and the economic environment. We also need to consider how much access to cash you might need.
This mix of investments, known as your asset allocation, is the single most important decision in planning a retirement, or indeed any investment strategy. A 1991 study by Brinson, Singer and Beebower determined that over 90% of long-term investment outcomes came from asset allocation decisions – NOT timing the market or stock picking.
While low rates make the idea of investing all your money in high yielding blue chip shares seem appealing, this is just as foolish as having it all in cash. Instead, the optimal portfolio needs to balance the risks of the various asset classes. And cash is important too, because if you have adequate access to cash you can avoid becoming a forced seller.
A word of warning, in periods of low interest rates all sorts of investment opportunities pop up offering high “guaranteed” rates of income. These often feature second mortgages, mezzanine finance or highly leveraged investments. In most cases your capital is locked away and the risk is very high. Product failures are common place. Bottom line is, if they are offering high returns, the risk is equally high.
Instead, speak to an Elston adviser about ensuring you have the right diversified investment strategy to achieve your goals.
If you would like more information please call 1300 ELSTON or contact us to speak to one of our advisers.