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Just because we may be compelled to have superannuation, is no reason to leave it to its fate. In fact, playing a role in how your super is invested is one of the key ways we can influence its outcome. Here we break down the key concepts to help you gain confidence with the investing side of super.
What is super investing?
We use the phrase ‘saving for retirement’ quite often referring to super, but saving is actually just putting money aside for a time to use on a specific purpose later. When we invest, we don’t just keep it aside, we buy something (referred to as an asset) on the premise that it will be worth more later, so we can outpace the cost of living.
Many of the principles of investing are the same inside super and anywhere else. Superannuation is simply a vehicle that holds your investments in an environment that the government treats more favourably for tax purposes than money outside of super.
Your money is pooled with other people’s superannuation money to buy and hold assets. Assets can offer profit in two ways: they may grow in resale value (called capital growth) or they may provide income such as rent or dividends.
If you have never made any active selection about what your super is invested in, it has been invested on your behalf until you’re ready to take more control, but more on that later.
Asset classes and the risk/return tradeoff
Anything that can be invested in can usually be grouped together by shared characteristics into types or classes. There are four primary asset classes: shares, property, fixed interest and cash, and they have qualities that allow us to generalise how they might behave over short and long periods of time. Then there are secondary asset classes that don’t neatly fit into the four main asset classes and whose behaviour can’t as easily be generalised. Sometimes termed ‘alternative assets’, they include infrastructure, private equity and even start-ups.
Let’s consider the main asset classes first:
- Shares are part ownership of a business listed on the stock exchange, priced daily and easy to trade. They may be Australian or international.
- Property usually refers to commercial real estate such as office space, hotels, retail shopping centres, factories and so on. Property may be listed or unlisted.
Shares and property are termed ‘growth assets’ for their general ability to produce high returns over long periods, but are also deemed the highest risk because of the potential volatility along the way.
- Fixed interest is about money lending. Governments and corporations issue these debt securities when they need access to cash. In return, they pay a set amount at regular intervals and at the end of the fixed term, pay back the loan amount in full.
- Cash refers to short-term deposits and cash management trusts.
Fixed interest and cash are collectively known as ‘defensive assets’ for their ability to give investors a smoother ride with less extreme highs and lows (lower risk), but they generally cannot produce returns as high as growth assets.
Here we see the trade-off between risk and return, one of the most foundational principles of investing.
Alternative assets also have this risk/return trade-off but because the underlying assets (which may be things like airports or unlisted businesses) don’t as readily share qualities like the four main asset classes, super funds will categorise their own alternative assets as either growth or defensive, depending on what the actual holdings are, to help you gauge their risk and return potential. So don’t be surprised if one super fund classifies their alternative assets as growth, and another labels theirs as defensive.
The benefit of super’s long-term nature
Super is designed to help you fund your retirement. For most people, it will be the longest-held investment we ever own. This can have great advantages:
1. With time on your side, risk isn’t a dirty word
Growth assets like shares and property (and some alternative assets) are considered the most ‘risky’ of the asset classes, because of their ability to fall most dramatically when markets decline. But history shows us that when markets recover, they generally recoup losses and then continue their journey upwards in value, giving the longer-term picture an overall upwards trend. So the longer you’re invested in growth assets, the more you can ride out short-term volatility and the less dramatic short-term movements will seem.
It is this long-term behaviour of growth assets that makes them suitable for long-term investments and gives them an important role to play in superannuation.
Then, as you approach retirement and get closer to accessing at least some of your super, you will likely want a little more certainty in your super returns. It’s wise to reassess how you’re invested in the five to ten years leading up to accessing your super. Diversifying further into the more defensive assets is the key way to create more certainty in the crucial time before and just after retirement.
2. Compounding returns
The other advantage of long-term investing is that returns compound, meaning that returns aren’t just calculated on what contributions go into your fund, it’s also calculated on the returns you derive each year, so in effect you get interest on your interest.
Is it time to take more control?
If you have never given your super fund any instructions on how to invest your super, you will have been placed into what’s called a default investment option, usually made up of a diversified mix of different asset classes so you get some exposure to everything. Traditionally, a default investment option is a fairly balanced mix of growth and defensive assets (and in many cases will also have the word ‘balanced’ in its name). But the default may be what is referred to as a ‘life cycle’ investment option that exposes you to more growth assets when you’re younger, and automatically shifts to less growth asset exposure as you get older.
You can check your annual statement, login online or call your super fund to find out which investment option you are currently in if you’re not sure.
If you decide there’s possibly one or more options better suited to you at this point in time, super funds generally offer a range of investment options to choose from. Selecting investments suited to you and your personal preferences is called creating an ‘investment strategy’. Most super funds will give you the freedom to move some or all of your existing account balance (called ‘switching’) and/or redirect your future contributions to a different investment option. There is usually a suite of diversified options (ranging from those weighted heavily towards growth assets to others weighted more to defensive assets) as well as more specialised options that may be comprised of just one type of asset class, such as Australian shares for example.
Your super fund will likely have tools to help you, such as risk profile questionnaires that help you understand your personal attitude to risk. Or you can get help from a financial adviser. You can speak to your fund about what’s possible, particularly which services you may be able to access at no extra charge.
Just as returns help our super grow, anything that is deducted (such as fees) will take away from our account balance. Some investment options require more scrutiny and management by your super fund than others so it’s normal that some investment options have higher fees than others. That does not necessarily mean those with higher fees will give you higher returns. (Investment fees are just one type of fee that super funds charge and it’s important to consider fees more broadly. You can learn more here).