As the COVID-19 crisis continues to grow, putting pressure governments, businesses and people globally, global financial markets have fallen from their highs to lows reminiscent of the global financial crisis. As a result, many concerned Australians, notably individual investors and super fund members have moved significant amounts of their invested savings out of investments and into cash for fear of greater negative returns.
However, by doing this many people may actually be doing more harm to their retirement savings than good. While it understandable that many investors can feel anxious or vulnerable when it comes to protecting their hard-earned savings - especially given the global uncertainties surrounding COVID-19 as well as the recent falls in the oil prices. There has also been considerable fear-inducing coverage of global markets and economies further instilling anxiety in investors.
Therefore, it’s important that investors take a step back to better understand how volatility in the market works and what that means for their savings and superannuation.
To illustrate, we’ve shared a small hypothetical example below.
An example of volatility
On 31 December 2019, the ASX All Ordinaries was 6802.
Suppose then, a person with $1 million in a super, planning to retire on 31 March 2020 with a pension on a minimum drawdown of 5% (note the minimum draw down for pensions has been reduced by 50% until 30 June 2021) would expect to retire on $50,000 p.a. or $961.54 per week.
On 20 February, they’d have popped the champagne because the ASX was 7255, their nest egg had increased to $1,192,864.19 and their expected pension to $1,146.98 per week.
But then by 18 March, ASX had fallen to 4998, their nest egg to $821,769.16 and their expected weekly pension to $790.16.This is volatility’s short-term impact.
However, it’s important to remember that time is a great leveller and that this same person is likely to have had investments during the global financial crisis in 2007-09.
Suppose again that they had $1 million invested in their super on 2 November 2007 just ‘before’ the GFC when the ASX was 6726. Less than a year later, on 6 March 2009 they would have been shocked when the ASX was as it lowest point at 3111, as they would’ve ‘lost’ more than half their super – about 50.43%. But even from that point to the current fall now on the 18 March 2020, the ASX has still increased by 60.62% since the lowest point of the GFC. This also doesn’t take into account the positive growth and performance of the market in the past decade as well.
So, that volatility which seems terrible right now may have little effect at all on your retirement savings if time is on your side.
Data from Industry Super Australia also supports this idea as they found that members who moved their retirement savings from an average balanced industry fund into cash after the GFC ended up being worse off as a result of missing out on important investment returns. They found that after three months, members were worse off by $4,000 and after seven years $46,000. Even though the state of the market did not look good during the GFC, since then, it has rebounded, performed well and delivered returns even stronger than before the GFC. (It is also worth noting that for some investors declines in the market during the GFC provided opportunities to obtain new investments at a significantly lower cost by adopting a dollar cost averaging approach).
Even in the case of someone looking to retire and live off their retirement savings today – such as in our example above – this person is likely to still have a long investment horizon. While they may begin to draw down on their investments immediately, for many people retiring today there are still 10, 20, 30 or more years for those savings invested to experience growth and deliver returns in the long run.
However, for those that do decide or have decided to move their money into more defensive assets like cash and bonds, it’s important to consider what short and long term impacts that will have on your financial position.
It is also important to consider the potential returns you will earn on those investments. If you moved a large proportion of your savings into a ‘standard savings account’ for example, the interest is so low (as a result of being in a low-interest environment) that you could be losing money year on year. According to Canstar, the average base rates of Australia savings accounts in 2019 was 0.92% p.a. and for term deposits 1.71% p.a. which were lower than the rate of inflation of approximately 1.7% for 2019. This means that in an average savings account or term deposit you are slowly losing the value of your money.
This can be one of the downsides of defensive investments. Generally speaking, the lower the risk of an investment the lower the potential for returns and vice versa. This is not to say that low-risk investments are a bad choice, but rather, that investors need to ensure they have a diverse portfolio that meets their risk appetite and goals. Regardless of this portfolio mix, it’s important to remember that there will always be a degree of risk in any investment, even a savings account. As such, investors should try to look at this period of volatility with a long term perspective when it comes to their superannuation.
Finally, one of the most important things that anyone can do when faced with concerns or anxiety over sudden fluctuations in their investments or superannuation is to seek professional financial advice. Speaking to an experienced advisor who understands your unique financial position, your goals and stage of life can help you to make the right decisions for you and keep you on track through both highs and lows.
Should you need more information about the effects of COVID-19 on your superannuation or investments or would just like to speak to an adviser, please contact Mark Wilkinson.
Mark Wilkinson provides financial advice under the license of BDO Private Wealth Advisers Pty Ltd, AFSL238280.
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