Last week's AFR contains an interesting article on housing affordability and a new front on the crisis. It addresses the emerging issue of retirees draining their superannuation savings to pay off their mortgages and then go on the aged pension. Effectively defeating the purpose of superannuation.
But in my view, the article fails to highlight the root cause of this.
Ten years ago I made an emotional decision. I entered the irrational word of the Sydney property market. And what made it especially painful was that I had to sell my beloved share portfolio to fund it.
Since then the asset side of the Mueller family balance sheet has had a healthy ride. This is thanks to a seemingly expensive property market becoming more expensive. There has been much opined about the property market, so I won’t go into it here.
But the liability side of the balance sheet has been a frustrating journey.
This might seem counter-intuitive. Interest rates have generally been on a downward path and, like the majority of mortgage holders, mine was mostly variable. I had mortgage brokers phoning me almost annually to offer me a larger discount to the standard variable rate. And it’s not like my loan to valuation ratio was astronomical.
The reason for my frustration is due a behavioural bias that is forced upon us by legislation.
Mental accounting – a behavioural bias
The bias is known as mental accounting. It is a behavioural bias where people categorise decisions for what is the same economic outcome. These tend to fall into two types, relating to either consumption decisions or payment decisions. Examples best explain them. And I’ll use myself as the culprit to describe the former!
Let’s say the cafe downstairs from Forager’s office increases the price of my beloved mocha from $3.50 to $4.00. “What a rip off,” I’ll think to myself. I’ll walk around the corner and go somewhere else.
But say I’m having a fancy $200 dinner and top it off with a coffee. I won’t even ask how much it is. And, rest assured, it will cost more than $4.
A budget constrained university student opens a bank account to save for a holiday. He or she then opens another account for a car. He or she incurs account keeping fees on both accounts. And he or she earns less as the accounts pay bonus interest as the deposits reach higher thresholds. So the student would be better off combining the two accounts to avoid fees and earn more interest.
But it gets better (or worse for the student). He or she also has a credit card that charges high rates of interest each month. Why not use the funds in the car or holiday account to avoid these high credit card payments? It would certainly result in a better economic outcome.
Like all behavioural biases, it is not an easy thing to avoid. Many people have trouble even identifying it. But it becomes most frustrating when one identifies it but legally can’t avoid it.
Legislation forces mental accounting upon us. We have 9.5% of our salary paid to a super fund and also have personal funds, be they for a deposit account, home loan or credit card.
Going super mental
Here’s the part that irks me. Most of my super is allocated to domestic and global equities. Over the last 10 years, the All Ordinaries Accumulation Index (including dividends) has produced a return of around 3.5% per annum. Global shares have done a little better, returning around 4%, or 5% if currency is counted for. These returns are before fees and taxes and don’t consider the risks of being invested in equities. In the meantime, my superannuation money could have been used to pay down my mortgage for about a 6% post-tax risk-free return.
Our former prime minister, Paul Keating, has a different take on this. Perhaps he is defending his legacy. But I think he misses the point.
Which brings me back to the root cause of the issue identified by the AFR. Those of us whose retirement is decades into the future are usually advised to put our superannuation into riskier assets like equities. This is because the long time horizon is sufficient to ride out the volatility of equity markets.
So superannuation is supposed to provide returns somewhere in line with equity markets. And then we would all be able to retire with a large nest egg. Paying off a mortgage would be a fraction of that nest egg. The problem is that superannuation returns don’t usually keep pace with equity market returns. I’ve addressed the reasons why at length.
And over the past 10 years most super funds certainly haven’t kept pace with the risk free rate for mortgagees. This means that I would have been better off ‘investing’ my superannuation dollars in my mortgage than giving it to most fund managers. But unless legislation changes, I’ll continue to be irked by mental accounting.
This article first appeared on the Forager Bristlemouth blog (VIEW LINK)
Daniel joined Forager in April 2016 as a senior analyst / portfolio manager for the Australian Fund. He is an avid value investor having previously worked at Investors Mutual and MMC Asset Management. He has a Bachelor of Commerce degree...
Comparing equity returns from 2007 onwards....a bit like 1974 onwards in reverse methinks.