This listener requested episode goes through what steps you should take when considering the different options available within a super fund.

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Shani Jayamanne: Welcome to another episode of Investing Compass. Before we begin, a quick note that the information contained in this podcast is general in nature. It does not take into consideration your personal situation, circumstances or needs.

Mark LaMonica: It's been a big week for us, Shani. On Monday, it's Thursday now that we're recording this. On Monday, we presented at a conference.

Jayamanne: Yes, the sixth annual Asset Allocation Strategies Conference. Presented by the International Business Review.

LaMonica: Get your tickets now before next year's, the seventh annual sells out. But I don't know, how do you think it went?

Jayamanne: I think it went pretty well.

LaMonica: Yeah, like I think it went well for you.

Jayamanne: Why do you think, we were on the same panel?

LaMonica: We were, but you know, I had a plan and my plan was to warm up the audience a little bit with a couple of jokes and they all failed. I did this right at the beginning.

Jayamanne: It wasn't your fault. It was a very serious audience.

LaMonica: I didn't even get like a pity smile from anyone. So I looked over at you and you're like horrified at what I'm saying.

Jayamanne: Well, I had prepared some jokes too and I knew they weren't going to land, so I just never tried them.

LaMonica: No, that was smart. So, I saved you.

Jayamanne: You did. I guess you did.

LaMonica: Yeah, but anyway, a little bit of a tough crowd, but there is a point to this. So it was the first time we presented together.

Jayamanne: Yeah.

LaMonica: At a conference, which I thought was nice.

Jayamanne: It was nice.

LaMonica: And one of your friends commented, iconic duo, epic duo. Yes.

Jayamanne: On LinkedIn.

LaMonica: On LinkedIn, yeah. The exciting social media platform we use. So at the beginning of the presentation, I put together a slide and I had to do the work on this presentation because, well, I'll talk about it a second, Shani was busy. And on this slide, I put together all of your accomplishments in just the last couple of weeks.

Jayamanne: It was a very serious audience and I was already horrified and then this came up.

LaMonica: Well, exactly. You didn't know it was in there. It was a surprise because I know how you like surprises. So let's go through all the things you were doing.

Jayamanne: Let's not Mark.

LaMonica: While, I was completing this thing. You were a finalist for a Woman of the Year award.

Jayamanne: Well, it's not the Woman of the Year award. It's a Women's Leadership Award.

LaMonica: Okay. You're finalist as the women's leader of the year. You spoke at South by Southwest.

Jayamanne: I did.

LaMonica: Which I think is impressive. I went to a Bucks party or I was at a Bucks party at South by Southwest, like the concert part a long time ago.

Jayamanne: Yeah, not the financial…

LaMonica: Yeah. In Austin, Texas.

Jayamanne: …literacy part of the conference.

LaMonica: You published an editorial in the Sydney Morning Herald and whatever other papers it goes into. And the Housing Minister reached out to you.

Jayamanne: Well, it wasn't her. It was her media advisor.

LaMonica: Okay. Well, that's basically the same thing. Okay. The point was that I put up that slide and I was going to tell this joke about JFK. And JFK went to Paris in 1961.

Jayamanne: Were you there?

LaMonica: I was not there. I was at home watching on my black and white TV. And all the attention when he showed up in Paris was on Jackie. You know, she could speak French. She was into fashion. So everybody was very into Jackie. And JFK went into this press conference and he said, I'm the guy that's here with Jackie on this state visit. And all of my other jokes had bombed. So I decided not to tell that joke. But I thought that was the best one.

Jayamanne: I feel like it was a pretty good call not to say that joke. It's very nice though.

LaMonica: Yes. But the point of this whole thing. So to circle back to the beginning. This conference was on asset allocation, as Shani said. And I know that a lot of the people in the audience, they're listening to this obviously wish they saw our presentation, but we're going to bring up a couple of points from it. So one of the things that we talked about that I thought is an interesting stat and you're really into stats and you're the more interesting one of the two of us. So why don't you give this interesting stat that we presented at the conference?

Jayamanne: There's a lot of compliments in this, Mark. Thank you. Well, AustralianSuper is the largest super fund in the country. And 90% of AussieSuper members are in the balanced option. And I think it's safe to say that makes it the most popular super option for all Australians. Nearly 3 million people are in the AussieSuper PreMixed Balanced Option.

LaMonica: Yeah.And another interesting and related fact is that the average age of an AussieSuper member is 42 years old. And I bring, yes. So Shani wants me to say that I bring, I'm an AussieSuper member, I bring the average age up.

Jayamanne: That was what I was going to say, but I held back since you were so nice.

LaMonica: Yes, because I actually really like you and consider you a good friend. You, I don't know what. But yeah, I can barely remember what it was like to be 42. But I do know something about super. And the whole point of saying the average age was not just to set Shani up with a joke, but we can't talk about any single member that has picked that balanced option. But given that average age, we can say that a lot of those members should not be in balanced.

Jayamanne: And the reason we say this is because the last report from AussieSuper showed that 24% of the balanced option was in defensive assets. So with a long timeframe to go, we think it is more conservative than many of those people should be in to reach their goals.

LaMonica: Now, some of you are listening to that statement and thinking, what do you mean goals? So the people who picked balanced were most likely looking at their risk tolerance or how much volatility they could withstand and rationally opted for a portfolio with lower volatility. Well, that may be why those balanced option investors made their decision. We just don't think it's a very good approach.

Jayamanne: We think for long-term investors, the biggest risk is not volatility. We think the biggest risk is that they won't achieve their goals. And if you look up risk in the dictionary, it's defined as something bad happening. We just don't think that something bad happening for an investor with decades before retirement is volatility. We think something bad happening is not having enough for retirement.

LaMonica: And to prove this point, to prove what we're basically saying that we don't think most people can get to those goals, we modeled out a couple of scenarios. So over the last 10 years, the high growth option for AussieSuper has delivered annualized returns of 9.04% a year. The balanced option with those 90% of members in it has delivered returns of 8.07% per year. So if we extrapolate those returns out for an investor contributing $10,000 a year into super for 35 years, the investor in the balanced option would have $1,750,000. In the high growth option, the investor would have $2,176,000. So that is almost 25% more in retirement savings. So those are obviously substantial differences in outcomes. And we looked at this in a little bit of a different way also. So I used the round number of $100,000 as a starting salary to make things easier on myself. The same model will apply to any salary though.

So the same example. So after the 15% tax on super contributions, this equates to an annual contribution of $9,775. This saver will spend 40 years in the workforce before retiring. And I'm assuming wages will increase at a 3% annual rate to keep up with inflation. So what I did is I calculated the income replacement rate at both the rule of thumb 4% withdrawal rate and the 5% withdrawal rate, which is mandated by the ATO after the age of 65. So this hypothetical retirement saver that I was talking about was able to replace about 50% of their income at a 4% withdrawal rate and 63% at a 5% withdrawal rate. So this isn't a great outcome because the rule of thumb is that you need to replace 70% of your salary at retirement.

Jayamanne: And there are many factors that go into this. What kind of lifestyle do you want in retirement? Do you own your home outright? But once again, it gives us confidence to say that for many of the people in the balanced option, they will not get to the retirement outcome that they need. And remember that there were lots of assumptions in what Mark said. The first assumption is that somebody stays continually employed and continues making contributions to super for 40 consecutive years. This is not reflective of the reality for a lot of people. It means never having a period of unemployment. It means never taking time off to care for a child beyond the paid parental leave period or to take care of an elderly parent. It means no periods of part-time work. It means never paying capital gains tax on any of the investments in super.

LaMonica: Yeah. So as I said, not a great outcome. And more than anything, this demonstrates that many of these investors in the balanced option are asking the wrong questions. They are looking at risk tolerance and not risk capacity. So risk tolerance is how much volatility can you handle? Which is a terrible question, as we've talked about before on this podcast. It's kind of like asking somebody, how would you react if someone pulled a gun on you? We can speculate on how we'd react, but we haven't gone through that experience. It's nothing more than a guess.

Jayamanne: We don't have those scenarios here in Australia.

LaMonica: Okay. Well, I was bringing a little bit of America to this podcast.

Jayamanne: Risk capacity is how much you need to take in order to achieve your goal. And that is a very different question, but it is based on what you're trying to achieve. And knowing that matters, because when volatility happens and your super account drops in value, at least you know that is the price that you need to pay to get to where you want to be. And to me, knowing that you're going to get through some pain to achieve something important is a lot better than just going through pain.

LaMonica: What example do you think would have been better in Australia? Like some sort of poisonous snake or spider or somebody pulls like a boomerang on you? Like, what is a good Australian example?

Jayamanne: Let me have a think about it.

LaMonica: Okay. Well, you have till the end of the podcast, because I'm going to ask you again. So getting back into our super example. So the simple answer to the question this podcast episode is asking, which option should you choose in super? Is the option that has a reasonable chance of helping you achieve your goal. But of course, we're going to dig a bit more into that. But let's start with some basics, Shani. Investors spend time thinking about which super fund to choose. Should it be AussieSuper or UniSuper or Self-Manage Super? And it isn't that we don't think that that's an important question. But ultimately, unless you are getting your drunken Uncle Larry to invest your super in the Pokies at the local pub, a far more important question to ask is if you picked the asset allocation that's appropriate to your goals.

Jayamanne: That's right, because even your moderately sober Uncle Mark can tell you that the biggest driver of returns by far is the asset allocation that you choose. And in a world where many investors are choosing from premixed super options that is directly related to the options that you choose.

LaMonica: So the first way we do this is to try to understand how much money you need in retirement. So I wrote an article on this, goes step by step, how to do it. And we did a podcast episode on this, right? Yeah, so listen to that, we'll put those links in the show notes. But knowing how much you need for retirement enables you to calculate your required rate of return to reach that goal. And we've also done episodes on that and have articles available explaining it. So if you do this, right, then you can just look at your required rate of return and compare it to the returns achieved over time by different options in the super fund.

Jayamanne: And we know that this reflects the past and the future can be quite different. But look at the longest period of returns available for each option and just compare that to your required rate of return and it should give you a ballpark idea.

LaMonica: And we're going to do a bit of this. So every year Vanguard puts out this chart and the chart shows 30 year returns for different asset classes. So we'll look at growth assets. And to represent growth assets, we'll assume a 50-50 allocation to Aussie equities and global equities. And then for defensive assets, we'll use Aussie bonds. So just an Aussie bond index.

Jayamanne: So over the 30 years, if you invested in growth assets, your return would be 10.1% a year. A 90% allocation to growth and a 10% allocation to bonds would be a return of 9.65%. 80-20 would be 9.2%. And finally, a 70-30 mix would be 8.75%.

LaMonica: So people may be listening and think that doesn't sound like much. But we have to remember that this is retirement. So this is a really long-term investment. And those little differences obviously make a huge impact on how much money you end up with over the long term.

Jayamanne: So the government has introduced the MySuper option, which is the default option. For AussieSuper, that is balanced. But here is our challenge to you. For anyone with a long time until retirement, I would do something else. Mentally, your default should be the high growth option because as we demonstrated, most people can't get to that rule of thumb retirement option in a balanced fund. So start with a high growth and come up with the reasons why you shouldn't be in it.

LaMonica: And of course, maybe your conclusion will be that you shouldn't, but have a reason for it. And no matter how old you are, we suggest you spend some time coming up with an estimate of how much you need for retirement. Even if it's a long way off and that estimate will change as your circumstances change, it's at least a good start. And estimate your required rate of return. We promise you that it will help with the different financial and investing decisions you are making. It will help with your savings rates and it will help with making decisions around asset allocation and picking the right option in super. So there we have it. Do you have an answer yet for your Australian scenario?

Jayamanne: I do. How do you know how you're going to react if you get swooped by a magpie?

LaMonica: Okay. In my case, it happened and poorly is the answer. And we know that you are terrified of birds.

Jayamanne: Yes.

LaMonica: So you were telling me another bird horror story the other day about a goose.

Jayamanne: Oh, yes.

LaMonica: That came after you. But anyway, you can probably tell the episode's over. Thank you guys very much for listening. We really appreciate it. My email address is in the show notes. Send me any questions that you have. And of course, we would love a comment and rating in your preferred podcast app.