The Actuaries Institute has proposed the introduction of a new superannuation risk measure that calculates the likelihood of not building up enough wealth for a comfortable retirement.
The risk of a superannuation investment option is generally measured by how many years of negative return you can expect over a 20-year period. This is called the standard risk measure.
It is a sensible approach to risk, but what it doesn’t tell you is that you can take too little risk.
A 25-year-old who has selected a cash or even a conservative investment option is likely to never build enough wealth to live a comfortable retirement. This risk is not about losing money; it is the risk of never accumulating enough in the first place.
To make super members more aware of the required level of risk in their investments, the Actuaries Institute is proposing the introduction of an additional risk measure.
This risk measure calculates the probability of achieving a long-term average investment return of the consumer price index (CPI) plus 3 per cent, a common investment objective among MySuper options.
Looking at investments in this light, it becomes quickly apparent that conservative options for young members are rather risky.
The standard risk measure is about how many negative annual returns you get in 20 [years]. It's not terribly important for a 20 or a 25-year-old that they've had one year of negative returns
In the discussion paper, “Complementing the Standard Risk Measure: Framing Super as an Investment for Retirement”, published last week, the Actuaries Institute calculates the chance of failing to achieve CPI plus 3 per cent over a 20-year period is 79 per cent for a conservative option with a growth/defensive asset split of 30/70. For the cash option, it is 100 per cent.
“The standard risk measure is about how many negative annual returns you get in 20 [years]. It’s not terribly important for a 20 or a 25-year-old that they’ve had one year of negative returns,” David Carruthers, one of the authors of the report, says in an interview with [i3] Insights.
“For a young person, the risk is that they don’t have enough money; that they don’t take enough investment risk to achieve a decent return.
“We think cash or conservative options for a young member are risky. You’re running the risk that you won’t achieve a return sufficient for you to have a comfortable, adequate retirement. It’s a combination, obviously, of how much you put in plus the investment risk that you take.”
And it is not just for 25 year olds that this is relevant. Even members in early retirement will still have their account balances accumulate for decades.
“The [standard] risk measure is for those people who want to access their money in the next five to 10 years or thereabouts,” Carruthers says.
“Now, for a retiree who’s only taking out a small amount, they still may want to consider the adequacy risk measure rather than the standard risk measure because most of their money is still going to be in there for another 10 years or 20 years, hopefully.”
One Step at a Time
The dequate Rirsk measure is intended to make people aware of the risk of not building enough wealth to lead a comfortable life in retirement.
But it is still a relative measure; CPI plus 3 per cent over nothing is still nothing. Asked why the Actuaries Institute didn’t aim for a certain level of income or a percentage of last earned wages and Carruthers says it didn’t try to solve everything all at once.
“We’re not trying to come up with an all-encompassing measure that kind of says: ‘Hey, are you going to have enough money when you retire? But really, are you taking enough investment risk along the way?’” he says.
He says the authors of the report, who also include Estelle Liu, Ian Fryer and Hailey Cai, did contemplate including the retirement phase in their measure, but ultimately chose not to overcomplicate matters.
“There is a danger that we’re introducing just another risk. Are we just making it even more complex to people so that they then turn off completely?” he says.
We're not trying to come up with an all-encompassing measure that kind of says: ‘Hey, are you going to have enough money when you retire? But really, are you taking enough investment risk along the way?
Some funds have already started reporting their version of an adequate risk measure. For example, Aware Super includes in its product dashboard a measure that calculates the chance of failing to produce a return of CPI plus 3.5 per cent per annum.
AustralianSuper includes in its product disclosure statement a timeframe risk measure that tells the member how risky an option is based on three time horizons: if they only have five years to invest, five to 20 years or more than 20 years.
“Three time periods is more accurate, so to speak, but that is also more complex,” Carruthers says.
“So we stuck with two risk measures, a shorter-term one, which is the standard risk measure, and a longer-term one, the adequate risk measure.”
The full discussion paper can be found here.
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