13 November 2017
Over the past week Australian shares were up 1.4% while small company shares rose 1.7%. Shares in developed countries were down 0.3% with the US market losing 0.2%. Shares in emerging markets rose 0.2%. The Australian dollar was up 0.1% to 76.61 US cents. The Australian 10 year bond yield increased to 2.61% while the US 10 year bond increased to 2.40%. The oil price rose 2% to 56.74 US dollars per barrel.
In late October, the internet lit up as Google released its new hamburger emoji. There was much debate around the placement of the ingredients in the burger, with Google placing the cheese underneath the burger patty, while Apple placed it on top.
You might be asking what relevance at all does this have to investments and member returns? It all comes down to sequencing; just as the order of ingredients placed in a hamburger impacts the experience of eating it, the order of market returns also impacts savings and member outcomes.
Consider the example of two investors, illustrated in the following chart, starting with $1,000 and investing it for 20 years in different investments. Assuming they make no further contributions during the 20 year period, they end up with the same result, even though they experienced an investment loss at much different times: investor one just before retirement and investor two earlier on in the term. In both cases, they achieved a return of 6.3% pa, assuming no fees, taxes and other expenses, over the 20 year period.
However, this does not represent the realities of super, where compulsory and voluntary contributions add to your balance. Using the same returns and 20 year investment term, and assuming the two investors each contribute $1,000 per month to their accounts, the actual balance at the end is very different.
Because of the timing of their contributions and the path of returns along the way, the ‘sequencing’, the outcome is very different. Investor one, who has investment losses at a date closer to retirement, ends up with a balance of $371,477 while investor two, who has investment losses earlier on, retired with $680,460 – 83% greater.
The example above illustrates that the impact of large negative returns close to retirement can have a significant impact on balances. For this reason, we offer a default Lifecycle Strategy, where a member is automatically moved to a less risky investment option as they get older.
In a similar way to changing the order of ingredients in a hamburger and the resulting impact on the eating experience, our Lifecycle Strategy aims to make retirement more palatable for members by managing the possibility of a large negative shock to your balance.
One final note: in the author’s opinion the best way to construct a hamburger is to place the cheese on top of the patty, followed by tomato then lettuce. Tomato or BBQ sauce depends on individual preference.
Robert Graham-Smith | Senior Investment Analyst