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Smart Investing
Market shocks highlight the importance of planning
 January 30, 2008
Robin Bowerman
Why Value, like beauty, is in the eye of the beholder.
Let us consider two quite different investor perspectives on this week’s sharemarket turmoil.
Jane graduated from university at the end of 2007 and took a well earned holiday before she is due to begin her career as an accountant on February 1.
Jane has a few thousand dollars in superannuation from several years of part-time work and a large HELP bill to wrestle down. One of the first choices she will have to make when signing up at her new employer’s HR office is what to invest her super in – the corporate scheme is attractive and offers choices of sector funds or a range of diversified funds – ranging from conservative to high growth.
At 23 years of age, Jane thinks the growth or high growth options make most sense given her circumstances. While she has never really focussed on super she knows it is for her retirement and that is 40 plus years away if she works into her 60s.
Switch hats now to James. He retired at 63 in October and converted his $650,000 super into an account-based pension so he could begin to draw down his pension tax-free under the new rules for retirement pensions.
James is understandably a lot less relaxed about the week’s market events than Jane. He was reasonably confident that his super would be sufficient to provide a sufficient income in retirement. Now he is a lot less sure.
His financial planner had modelled his portfolio with a 10% annual return figure and that showed he should be able to draw down what he felt was an adequate if modest income well into his 90s and of course there was the prospect of a part-pension depending on what the eligibility rules were at the time.
What Jane and James both have in common is time – Jane because she has her whole working life ahead of her and James because thanks to a healthy lifestyle and a family history of longevity he reasonably expects to beat the average life expectancy of 84 for men.
But of course James’ issue is that he has just seen his capital balance dip alarmingly and he has stopped working so he has begun drawing down money to live on. So going forward any market recovery will have a lower account balance to work with. No one likes seeing the capital value of their investment drop but retirees are particularly concerned by it because they know the chance to replenish the capital is limited.
So while in theory our two investors have 20 plus years as an investment horizon the behavioural and emotional influences are dramatically different. And that is where a sound financial plan can really be a tremendously reassuring companion during market turbulence.
If you are nearing retirement you need to understand the assumptions any financial plan is using – earnings rate, inflation and so on. This is something worth challenging your adviser on and perhaps getting them to show two or three scenarios – a high return environment, mid-range and below-average. It will give you a sense of how sensitive these things are to small variations. Long-run estimates are very sensitive to return rates because of the compounding effect so make sure you understand the detail of this part of any financial plan.
In James’ case his financial planner had indeed been conservative and in the asset allocation had put two years worth of James’ desired income in cash precisely to cover this unforeseen scenario so when markets fell suddenly there was no need to have to sell out of the growth assets to provide money to pay the bills.
James was relieved the plan was still on track but was still worried about the portfolio’s value so he decided to return to work part-time. Under the new transition to retirement rules he is able to salary sacrifice 100% of his earnings into his super fund (provided the salary is below the concessional limit of $100,000) and then withdraw his pension payments which are now tax-free.
Market shocks are just that. Very hard to predict or time. But a well designed financial plan combined with the new flexible retirement transition rules mean that people nearing or recently retired have more options and flexibility today than ever before.
More articles from this edition of CompareShares:
Trader profile: Trading for a living - Shean Gannon
Takeovers: Should you buy the bidder or the takeover target?
Resident Trader: The Trader's SMSF
Stocks: Stock of the week- Incitec
Commodities: Gold price spike a boon for gold producers
Smart Investing: Market shocks highlight the importance of planning
Expert Panel: Why would I buy an option over a stock I like rather than a share?
Rates: Why the RBA will not hike
Rogue Trader: France says SocGen is "in crisis"
Whatever your views, you can discuss this article - or any of Robin's articles - on our message board Your 2 Cents.
Robin Bowerman is Head of Retail at index fund manager Vanguard Investments Australia and the former managing editor of Shares and Personal Investor magazines. To receive this column by email each week go to http://www.vanguard.com.au/ and register with smart investing.
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