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When it comes to working out how best to invest your super – particularly as you get closer to retirement – one of the biggest headaches is which mix of investment assets to use.
How much of your super account to allocate to defensive assets (such as cash) versus growth assets (such as shares) can be tricky to work out – even for an investment expert.
New research by one of Australia’s leading retirement consulting firms has investigated how lifecycle funds slowly shift their asset mix over time, and it offers some interesting lessons for super fund members.
Lifecycle funds: What are they and how you can learn from them
Lifecycle investment funds (which are sometimes called target date funds), are based on the idea that investors in different age groups should not have the same mix (or allocation) of assets in their investment portfolio.
Lifecycle funds were developed by leading investment experts and are currently used by some of the largest pension funds around the world. They are also a popular approach in Australia and are used in investment options offered by many super funds.
With this strategy, the investment option automatically changes the amount of defensive assets compared with the amount of growth assets in line with your age – and shortening investment horizon.
Need to know
Your investment horizon is a term used to describe the total length of time you expect to own a particular asset or portfolio before you cash it in.
Different investors can have very different investment time horizons – particularly when it comes to their super savings. For example, someone in their first job who has just opened a super account may have an investment horizon of 40 or 50 years, while someone aged 62 may have an investment horizon of only three years if they plan to retire at age 65.
Your investment horizon matters, as the shorter your horizon, the less risk you will normally be willing to accept, as you don’t have time to ride out the normal ups and downs of investment markets.
If you don’t need your money for a long time, you can own a riskier mix of investments (usually a higher allocation to growth assets), compared to a person who needs their retirement savings in the next few months.
Lifecycle funds have evolved over time, with the first generation mainly focussing on your age. They usually emphasised defensive assets and de-risked their portfolio at a younger age. The second generation, on the other hand, focussed on growth assets and de-risked the portfolio at an older age – mainly to avoid sequencing risk. (For more about sequencing risk, read SuperGuide article 5 ways sequencing risk affects your retirement.)
The latest lifestyle funds are multi-dimensional and consider both your age and account balance. They adopt a high allocation to growth assets unless the fund member is older and has a low balance.
For more about lifecycle funds, read SuperGuide article What are lifecycle super funds, and how do they perform?
Crunching the numbers: Taking a look at lifecycle asset mixes
Rice Warner is one of the leading research and consulting firms working with Australia’s super funds, so it knows a fair bit about how super works. In a recent report, its consultants completed a detailed analysis of the implications of using different asset mixes depending on your age.
The Lifecycle Design – To and Through Retirement report is pretty technical and not for the feint-hearted, but it provides some interesting insights into the likely investment outcome when you change the mix of assets in your super portfolio.
The report used very complex simulations of what happens to the super account balance of a fund member depending on their age and the mix of assets (growth vs defensive) they selected.
The simulations found:
- Younger fund members (aged under 30) benefitted from being in an investment option with a high allocation to growth assets, as this asset mix spread risk over the many years until their retirement. It found this occurred without significant underperformance when there was an investment market downturn.
- Older fund members (aged 60) with high allocations to growth assets had improved investment outcomes in strong investment conditions, but experienced slight underperformance (2–5% over a fund member’s lifetime) compared to the return for a normal balanced fund with a mix of 70% growth and 30% defensive assets.
- Lifecycle funds focused on defensive assets and de-risking at younger ages (first generation funds) usually underperform other strategies in neutral or strong market conditions due to their lack of growth assets. When investment market returns are poor, these strategies outperform, particularly for fund members with low account balances.
- Multi-dimensional lifecycle funds manage investment risk and return better than simpler lifecycle strategies due to their more tailored approach and often outperformed other strategies in the research.
Lifecycle funds: What are the lessons for fund members?
Although reading the Rice Warner report is only recommended for true super and investment nerds, it contains some valuable lessons super fund members can consider when they are selecting an appropriate investment option:
- Your investment horizon is extremely important when it comes to selecting an appropriate investment strategy for your retirement savings.
- Adopting a high allocation to growth assets is not necessarily a bad strategy, even when you are in your 60s and approaching retirement.
- Don’t automatically assume the best investment strategy both before and after retirement is the traditional approach of boosting your allocation to defensive assets and reducing your allocation to growth assets.
- Take both your age and account balance into consideration when deciding how much to allocate to high growth assets.
- Younger super members usually have a better outcome when they choose a higher allocation to growth assets, as risk is spread over a longer investment horizon. Even in poor markets conditions, the underperformance of your investments will not be significant.
- The right mix of assets depends on the individual. There is no ‘correct’ asset mix for the years before and after your retirement. Different people require a different mix of growth and defensive assets and this depends on both their investment horizon and account balance.
- If you are in a MySuper investment option using a lifecycle approach, check the strategy it uses. For younger members, a lifecycle fund focussing on defensive assets and de-risking the portfolio (first generation fund) may not be the right strategy for you.
- Unless investment markets are weak, choosing an investment option or lifecycle fund that focuses on defensive assets and de-risking the portfolio, may not provide the best investment outcome for younger super members.
For more about investment choice, read SuperGuide articles:
- How to grow your super: Know your risk profile
- 5-step guide to deciding if it’s time to change your investment option
- How to choose an investment option for your super pension
- How to change your investment option: 6 points to check before you switch
This article is general information only and does not provide any recommendation on selecting a particular investment allocation, investing in a lifecycle super fund, or investing in any specific super fund. It is important to get independent financial advice when considering what financial products may be suitable for you.