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The past 18 months have provided a masterclass in investing for super fund members.
In the decade to early 2020, investors had experienced the longest bull run in history. But when the potential impact of the pandemic became clear, global markets went into meltdown. The Australian sharemarket plunged 36% in the month to late March 2020.
As Australians rushed to check their super balances, many younger members were confronted with a significant drop for the first time. Those near retirement saw their best laid retirement plans crumbling.
According to the Reserve Bank’s Financial Stability Review (April 2021), super funds increased their cash holdings by $51 billion in the March quarter 2020, and around half of this increase was due to members switching out of diversified balanced and growth investment options into cash. Switching activity was higher than in previous market disruptions, even the GFC, and was most prevalent among members close to retirement with larger super balances (and more to lose).
With the benefit of hindsight, we now know that super funds recovered to post their strongest results in 24 years, with the median balanced/growth fund up 18% in the year to June 2021.
So what are the lessons for members who cashed in their super chips?
Counting the cost of switching to cash
SuperRatings recently measured the impact of switching out of a balanced or growth option into cash at the start of the pandemic.
SuperRatings executive director Kirby Rappell said someone with a super balance of $100,000 in January 2020 who switched to cash at the end of March 2020 would have been around $22,000–27,000 worse off by the end of July 2021 than if they had not switched.
In a similar exercise, Russell Investments found that someone who started 2020 with a portfolio worth $250,000 and stayed invested, rather than switching to cash when markets were volatile, was better off by as much as $40,000 by May 2021.
In its 2021 Value of an Adviser Report, Russell modelled returns for three hypothetical investors, outlined in the table below. Each started 2020 with a diversified portfolio worth $250,000. Investor 1 stays invested, Investor 2 switches to cash on 15 March 2020 then buys back into the portfolio in November 2020, while Investor 3 switches to cash on 15 March 2020 and stays there.
Table 1: The investment impact of time in the market
|Portfolio value |
1 Jan 2020
|Portfolio value |
31 May 2021
|Investor 1 |
|Investor 2 |
(switches to cash Mar 2020, switches back Nov 2020)
|Investor 3 |
(switches to cash Mar 2020, stays in cash)
Source: Russell Investments
As you can see from the table above, switching at the wrong time can be costly.
It’s easier said than done to hold your nerve during a market meltdown like the one we experienced in 2020. During a market panic our fight or flight response kicks in. But the risk of fleeing to the perceived safety of cash is twofold; not only do you risk crystallising your losses after a big market fall, but you also risk missing the rebound in shares before you switch back again.
The benefits of doing nothing are even more stark over the long run.
The benefits of doing nothing
SuperRatings also tracked the returns of various investment options over the past 15years. As you can see in the graph below, share-focused options fared best, albeit with a higher level of risk and short-term volatility.
A balance of $100,000 in the median balanced option (60–76% growth assets) grew to $247,557 in the 15 years to July 2021, more than doubling in size. The same amount invested in the median growth option (77–90% growth assets) accumulated to $254,006 over the same period. Over the same period $100,000 invested in the typical cash option grew to just $151,158.
The role of advice
The best way to avoid knee-jerk reactions that end up costing you money in the long run is to work out the most appropriate investment mix for your age, long-term goals and risk tolerance. If you need help with that, then it may be worth getting advice.
Most funds offer free or low-cost general advice on topics including investment options.
“For members who want more tailored advice, some funds will offer comprehensive advice that will also take into account your financial assets outside of superannuation,” says Rappell. This comes at a price, but some funds will allow the cost to be deducted from your super account if you choose.
Alternatively, you may prefer to find your own independent adviser. Whatever your preference, an adviser can provide a valuable sounding board when markets are volatile.
Many people mistakenly believe the primary role of an adviser is to select investments, but it’s much broader than that. Like a sports coach, they can help you define your goals, develop a strategy to achieve them and give you the confidence to persevere when the going is tough.
The quantum of solace
The Russell Investments report mentioned earlier set out to quantify the value an adviser can add to your investment portfolio.
Overall, it estimated advisers added 5.2% or more in value to their clients’ portfolios in 2021. This calculation was derived from five elements:
- Preventing behavioural mistakes (2%)
- Advising on appropriate asset allocation (1.1%)
- Optimising cash holdings (0.6%)
- Tax-effective investing and planning (1.5%)
- Expert wealth management knowledge derived over years of market experience (priceless).
As you can see, preventing ‘bad behaviour’, like switching to cash or trying to beat the markets in response to short-term volatility, contributed most to client returns.
Next is tax-effective investing and planning, which refers to choosing tax-effective investment vehicles such as super and maximising the tax advantages of different types of super contributions.
Also critical is asset allocation, or the most appropriate mix of growth and defensive assets for your age and risk profile. According to Russell, research shows that up to 85% of investment returns are derived from asset allocation.
Cash management is also important. Holding too much cash can drag down returns, while holding too little in retirement may force you to sell investments at a loss in a prolonged downturn.
The past 18 months have been a roller coaster of emotions for super members, but the rewards have been great for those who stayed the course. If you found the going difficult, then it may be worth seeking out independent financial advice so you don’t repeat past mistakes.