Superannuation is often the second most valuable asset after the family home and with the compulsory employer contributions rate gradually increasing to 12 per cent by 2020, superannuation will play an increasingly important role in funding the retirement income needs for all Australians. Despite its significance, many people still have little understanding as to where their retirement capital is invested and the subsequent risks attached.
Despite most employers offering choice of fund options nowadays, industry research suggests that many take the path of least resistance and choose both the default super fund and investment option. Default investment options are determined by the super fund trustee and vary across providers. However, most will take a “Balanced” approach in respect to the investment mix and this generally means some level of growth assets (such as shares, property, infrastructure and private equity investments) are included in the portfolio.
A common misconception is that the default option carries less risk or even no risk than other investment options. So is your superfund’s default investment option really risk-free?
Many Australians learnt difficult lessons in risk management through the recent Global Financial Crisis. Many default investment options delivered negative performance returns through the tumultuous years between 2007 and 2009 as a result of investment mixes that included exposure to “growth” assets. For example, one of Australia’s largest industry superannuation funds, which use their “balanced” portfolio as the default investment option, has over 80 per cent invested in growth assets. For an investor with little risk tolerance or close to retirement, this investment strategy may not have been appropriate. Growth assets (or investment strategies with a heavier weighting towards them) usually provide higher investment returns over the long-term but are more likely to provide negative returns over shorter time periods.
Super fund trustees offer a number of investment options that allow you to take more or less risk with your retirement assets, the trick is determining the right investment mix for you. Here lies the problem with taking a default approach to your superannuation investment strategy, because you don’t need to be a default investor forever.
With so many fund options out there and so many investment options to choose from, it is easy to get overwhelmed when it comes to ticking your investment box. It is up to you, to first determine how much risk you are prepared to take with what is likely to be your largest income producing asset in retirement.
Ask your superfund trustee about risk tolerance and how to determine your own. Investigate the different investment options available to determine exactly where your hard earned capital is invested and the asset allocation applied to each. Critically important is to develop a strong understanding about how your risk tolerance and subsequent investment mix should be varied as you approach retirement. Ask questions, because super fund trustees cannot make these investment decisions for you. Professional advice may be beneficial as super and investment is a complex area and the earlier the issues are identified the more likely it is that your retirement goals can be achieved.
Default investment options do have risks and limitations primarily because they are not tailored to each individual’s specific circumstances and needs. Ultimately the net performance of the investments inside your fund together with your time to retirement and contribution rate will determine the level of capital at retirement age. Making informed decisions about your super investment strategy based on your own personal risk tolerance NOT a trustee default option is the key to giving you the best chance of achieving the retirement you want.
This article appeared in The West Australian newspaper on 26 August 2013