Let's take a baseline retiree as an example – An 70 to 80-year-old Australian couple with $1m to live off in a house with no mortgage in a zero tax environment.
They hold the classic Australian equities portfolio that averages out to a yield of around 4.5% plus average market franking (about 72%) taking it up to 5.89%. They have instructed all the companies they own to pay their dividends into a specific bank account, and they live off that bank account, about $45,000 a year plus an annual ATO cheque for somewhere between $10,000 to $15,000 depending on the franking. They have mostly banks, Telstra and hybrids. They are hopeful the bank sector will come right, and that they will “be alright in the end”.
For this couple, there are several issues that they probably share with a lot of retiree investors who are focused on income:
- They have lost trust in advice, especially after all that Royal Commission stuff. They feel that they are ‘on their own’ and everyone in the finance industry is a predator.
- Their focus is on the bank account that the dividends get paid into. This determines whether they feel ‘poor’ or ‘rich’. They have sort of lost sight of the ‘capital’ and whether it’s going up or down. The income from their shares dominates the mood because that’s what they live on, and their sole focus is that the income doesn’t go down.
- They have to budget for the months when no dividends come in. Stocks only pay twice a year. Thankfully for them, the CBA and Telstra dividends are three months out of sync with the ANZ, Westpac and NAB, so they get income every three months. But still it’s not regular income, dividend cheques arrive in lumps which means they are sometimes hanging out for dividends to arrive before they can pay some annual bills.
- Because the franking can take up to eighteen months to arrive they only really budget to live off the dividends as they arrive. The franking credit refund, which arrives in one big ATO cheque, after they put in our tax return, is not part of the living expenses budget because they use it to cover one-off items like holidays, cars, the bathroom renovation. They thank the Lord on a daily basis that Bill Shorten didn’t get in and get rid of this refund.
- They don’t enjoy worrying about the equity market, it’s more stress than pleasure, especially when they are not experienced, confident, IT savvy and are losing their marbles. They don’t want to pick stocks and trade. But they are still exposed to it, and they invest with their fingers crossed behind their backs.
- They can’t afford another once in a lifetime stock market event like the GFC. Another GFC now would be like that meteor was to the Dinosaurs and if it happens again they don’t have a fallback, they just assume, hope, it won’t happen. They cannot afford to have the equity market fall, not on $45,000 a year, but still they remain exposed because of the dividends and that franking credit refund. They have to preserve capital but they still have money at risk.
- Inflation is an issue. They know the RBA says its less than 2% in the official figures, but the Australian Bureau of Statistics obviously don’t eat anything, insure anything, have utility bills, drink coffee or drive anywhere. And they obviously don’t have to buy birthday presents for twenty grandchildren or be the bank of last resort for the financial failures of their kids. ‘Real’ prices are going up and they are irritated by a government that pretends they aren’t.
- They aren’t big spenders but on a bit more than $45,000 a year, they are cutting into their capital each year and can afford less and less not more and more.
- All in all they feel poor and with ‘real’ inflation included their standard of living is going backwards, and after a lifetime of work, it seems unfair that being a millionaire means being poor.
OK - There are a few things going on here, a few assumptions being made that are incorrect and the most obvious one is this. The assumption that a millionaire will be able to live off the income they earn on their capital is no longer true. The decades of 5-10% risk-free returns are over.
Happiness is all about expectations and if happiness in retirement is income expectations met then the guaranteed way to be happy is to have very low income expectations. So lets set some realistic, zero interest rate environment expectations, expectations that you will not find the average financial planner preaching to their clients yet, but should. For instance:
- Assume interest rates are going to zero, Philip Lowe is trying to prepare us for that.
- Assume that bonds and other risk-free investments are going to yield next to nothing. They already do.
- Assume that inflation in retirement is higher than the risk-free return (we now have the first negative ‘real’ risk- free return in decades).
- Assume that the banks are going to cut their dividends and franking. The ANZ just did.
- Assume that the stock market return is not reliable in your timeframe.
- Assume you want to stay in your big house.
Now what are you going to do, because as the real risk-free returns tend to zero, the dollar threshold at which you can consider yourself “wealthy” and able to retire is rapidly rising as interest rates and reliable income sources fall. Arguably there are going to be no risk-free returns before long, and that means you will need a lot more capital to retire.
So what do you do?
The most obvious thing is that retirees are being pushed into the equity market looking for a yield and in so doing are putting their capital at risk, possibly at just the wrong time, when the equity markets are pumped up on money printing, are at the mercy of the new ‘Trump Tweet volatility’, and just as the yield curve inverts suggesting heightened recession risk.
What needs to happen is that the mindset of not just retirees, but the whole financial advice industry, starts to question their history-based, blasé optimism, that promises clients the old risk-free returns of 5-10%. The risk-free return is going to zero which means that 5% is now a 'risk-return' not a risk-free return.
There was an article in the financial review recently entitled “Brace for 5% super fund returns” which suggests that superannuation funds should consider downgrading their “promise” to members to reflect the likelihood that they are going to get lower returns. It says “For the past decade retirees over 65 have been fortunate enough to be able to draw the government-mandated minimum amount of 5 per cent from super yet keep saving because they were earning 7 per cent. As a result many people in their mid-70s now had more money than when they retired. That is unlikely to be the case for those retiring today, and Super fund communications, including retirement calculators, need to show the impact of potentially worse outcomes relative to the past. Consequently, more members will need to draw down their capital earlier.”
Bottom Line: The financial advice industry needs to take negative real risk-free returns on board and start putting together financial plans that include spending capital because the income is almost certainly going to dwindle, possibly to zero. We need to kick clients out of the fantasy that they are going to be able to live risk-free off income alone and still grow their nest egg every year after expenses. We need to put 'making and spending capital' into our spreadsheets and inform our clients that their ingrate children are going to have to make their own money.
My next-door neighbours, an old couple, lived in abject poverty. When finally they both died within a year of each other, the For Sale sign went up on their house and their wealthy daughter pocketed $999,000. Depending on where your finances are, leaving your share portfolio and your house to your children may be a luxury you can’t afford. I have a name for a financial plan in the zero interest rate environment, a name that encapsulates spending capital as well as earning income - it is called the “Penniless at 100” plan because unless our clients are really wealthy, that’s what they are going to be.
Footnotes:
- Expect a boom in one level half block no garden houses for downsizing retirees.
- Pre-retirees need to start saving and stop spending because they are going to need a lot more than their parents to retire.
- Any fund managers that can reliably achieve capital growth in a zero interest rate environment will attract billions.
- Reliable 5-10% earnings growth stocks with high payout ratios will become the new ‘sexy’ in the equity market.
- Get rid of that spare room, or your kids are never going to leave.
Read more from Marcus
Marcus Padley is the author of the Marcus Today stock market newsletter. To sign up for a 14-day free trial please click here.
peter calo
Perhaps what this couple need to do is to get rid of their Telstra shares, slash the number of bank shares and invest the money into true growth assets. Things such as CSL, Resmed, REA, Seek, Macquarie, Microsoft, Alphabet of a Nasdaq ETF? If this couple has to learn to eat into their capital, they better make sure that capital is growing. Oh and they should tell their kids the bank of mum and dad is permanently closed and they should stop asking for money to pay for their kids private school fees.
Mervyn Cross
Good article. My aim is to keel over just as I spend my last dollar. All I have to do is get the timing right.
Stuart Brooke
I felt most uncomfortable as a 77yr old reading this article. Marcus is absolutely spot on and it updates an article he wrote several years ago that you need to own your own home and have $1m in assets at age 80 and you'll be OK. Clearly, as Marcus has eloquenyly expained, this is sadly no longer true. Stuart
paul johnson
Finally a market analyst speaking sense and the truth
Marcus Padley
Good comment Harry - its taken me 59 years to realise the things that really fulfill me - Emma, the kids and hitting a three wood onto a green 230m away!
Roger J ALLAN
Marcus - a great article - cannot really fault it - I look forward to your best guess at an antidote?
Mark Dawson
Thanks Marcus, what a good, fun article and I love all the comments your readers have left. Enjoy your family, friends and golf. I think I'll do the same. Kind Regards Mark.
Carl Bowden
Good article Marcus and I'm glad to see someone daring to suggest that people should spend some (or all if needed) of their capital during retirement. You hear of so many people not wanting to touch their capital and only live off investment income so that they can "leave something for the kids". Super was designed to be what you live off during your retirement, not a vehicle to leave an inheritance behind once you keel over. Personally I intend to leave as little as possible on the table when I slip off the twig. I also agree that people are going to have to get used to much lower returns that in the past.
Nicolas Game
You are exactly right. Retirement planing needs to include drawing capital and income just as investing should focus on total returns not just dividends. There are many simple free amortisation calculators available to people where you can input some simple numbers and work out exactly how long your savings will last. if I end up penniless at 100, so be it.
Stephen Cocker
Fantastic article Marcus, you get right to the heart of the problem that is facing many people my age.
keith hughes
Loved it Marcus, as always to the point. I fear for many of my octogenarian friends who are oblivious to what lies ahead and appear immobilised about changing their approach to more relevant investments; your comments should awaken them but many still rely upon olden day advisors. It is so hard for many to let go of their previous favourite investments even the old darling AMP. Why is Economics 101 not taught in primary school. Turning 85 next March, I hope to relate your anecdote (with acknowledgement) about your presentation at the RACV; what the listener observed then remains as true as it ever did. Perhaps your readers need a refresher on this enjoyable recollection. Regards Keith>
Sarah Pitt
The only problem with the old ‘money doesn’t bring happiness’ adage is that you have to have money before you realise the truth of it Money brings a level of comfort - not happiness - but having been on both sides of the equation I know where I’d rather be!
Warren Smith
Great article and as always enjoyed your refreshing frankness, currently in my late 50's and have come to the same conclusions re what to expect re retirement income. Problem is, as you state most advisers are quoting returns that do not come close to matching the reality we now face and will continue to endure! PS Love the ingrate children line.
Carlos Cobelas
that's true Marcus but without money you won't afford the golf club fees and your wife will get pretty ratty..... if a million dollars is not enough, and I agree, why on earth does our silly government restrict concessional Super contributions to a mere $25K per annum. it is nowhere near enough. and I wholeheartedly agree with Peter Calo. sell those damn Telstra shares !
Garth Abercrombie
I had to laugh that I was so predictable. Ticked all the dot points!! I'm ok though. I read these columns and am reasonably aware of what is going on. I feel sorry for those people who rely on financial advisers who are only interested in skimming their 2% off some pretty poor invwstments.
Greg Johnston
Marcus, the best article on this issue that I have read in a very long time. As a recent retiree in my mid 60’s, your assessment has ‘nailed it’ in terms of how I (and I assume most retiree’s) regard our capital i.e. it’s OK to go without during our retirement years just so long as we preserve our capital so we can leave something for the kids. You are right, we (and the whole financial advice industry!) urgently need to change our current mindset towards our capital base as we progress in our retirement i.e. use it if we have to (the kids will just have to make it on their own – like we did!).
Michael Croft
And to prove the point, Westpac has just cut dividends by 7%.
Michael Ward
Good article Marcus you hit the nail on the head. It felt as if you were speaking about me, now all I have to do is follow your advice and start living
Marc Alderding
Here is a REAL case for you to consider: a 72 yr old single woman, 500K invested in SMSF (managed by financial/retirement advisor, a well-known group). The investment returns 25-40K/yr, 36K/yr is taken out for living, 10K/yr paid to advisor for total of all advise/admin fees (results in optimistically a negative capital change of -6K/yr +/-). The real issue here are the historical rate of fees paid to manage this investment. Not only are the fees comparatively high but the service proved to be slow and did not perform even close to leading industry standards. The complexity and poor response from the advisor group eventually lead to the SMSF being dismantled and move back to a leading industry fund. (performance tracking at around 9-10% after fees[@~0.8%] = new investment return ~45-50K/yr, 36K is taken out for living (projection of positive capital balance +10-14K/yr +/-)
BARBARA FINCH
Oh wow, Marcus you're 100 % right.
peter oag
Honest article that was relevant the first time I read it, and equally valuable to re-read at regular intervals
Paul Ujj
What will be the impact on growth as an ever larger fraction of the population cut spending to make their capital last as long as possible ? Re: cuts to super contribution limits - governments were losing too much tax income which they need NOW to buy votes.
bryan brown
The government can help at times like these by reducing (or scrapping altogether) the compulsory minimum amount that has to be taken as a pension. This would be no skin off their nose and would allow a retiree to be flexible in deciding for themselves how much they need to live off. Why should I have to take 6% if I need only 3%. I can't think of any downside to it.
Marcus Padley
TO MARC ALDERDING - There is nothing wrong with getting the compounding return from a big Super fund company that does no more than administer your exposure to an average return. The only time this won't work for you is when there is a GFC style event (the 20% corrections are normal - you need only fear the abnormal). They are very rare but what the big fund investors need to understand is that, should it occur, no-one will tell you to sell. That is the main weakness of the big boring managed fund solution. So as long as you know your login, where to go on the fund's website to click "Cash" as opposed to "Aggressive" and understand that the only person responsible for that decision is you, you should be fine. Big average funds are for bull markets onlt - in a bear market they will ride you all the way down as well. On that basis a lengthy bear market is all you need to worry about. When you think (for whatever reason) its possible, click "cash". You can always click "Aggressive" the next day or when the clouds clear, but you must understand, the industry's job is to get you in, they'll never advise you to get out....but just sometimes, you (emphasis on YOU) need to.
Rob Garnsworthy
Why let the facts get in the way! Reality: 1) For retirees there is NO difference between capital gains and franked dividends - 30% on Csl beats 7% gross dividends 2) As we age the "system " forces retirees to draw down thier capital with the minimum draw down rate climbing from 5% to 11% pa when/if you make 90 In that world, capital growth is the target and while for many that may be difficult to get their head around, the advisory industry best wake up
David Roberts
I'm 80 so Marcus's article is pertinent, butone thing Marcus has forgotten about - if you need to go into aged care, you need to find a bond of between $600,000 to $1million. If we could 'die in dignity' at a time of our own choosing then one wouldn't have to squirrel this money away. who wants to go into aged care if you don't know who you are, who your spouse is, who your kids and grandkids are. It's a total waste of money being kept alive as a vegetable. Politicians should leave their religious views at the doorsteps of Parliament House. In terms of investments, nearly all of my stocks, ETFs etc are international and have returned ~ 20 - 30% this year. Income can be realising capital gains or dividends - I choose to maximise my gains.
Rosie Sargeant
Spot on Marcus. We are above average earners with kids in secondary school and can pay mortgage off tomorrow. At 50 years of age I can see how without changing the mindset, retirement could in fact be "penniless at 100". Sad that by earning well, living modestly can actually still mean a poor standard of living for 20-30 years of retirement.
Apurv Baviskar
fantastic. Great article stating reality
Tom Harbrow
Marcus, I run a SMSF with two members, am 73 and have a passion for stock markets and all that affects them, even things unheard of a few years ago, like a Trump "tweetstorm" Fortunately after owning my own business' since I was 16, mainly in mining, contracting and horticulture have sufficient assets left to be OK, but would like to share a couple of 'left field' events and have a wild guess at another couple of these that I believe are being missed and will affect investment's, maybe sooner than later, a couple of my unexpected events , we brought a warehouse,showroom,office in Darwin in 1990 and had the same tenants all these years, bringing in a net $82k p/a, unexpectedly and through no fault of the tenants this has turned into $20k , second event was in 1980 when mining silver/lead, sent a $350k parcel to Port Pirie smelter, while in transit the Bunker-Hunt fiasco unfolded and the parcels value became $60k, now my wild guess about the future, because of my background I don't touch tech, medical or pharma stocks but watch and invest in early stage mining that meets my criteria, an observation of the resource industry in general, as China gets more internal issues and increasingly pushy, aggressive and interfering in Asia, Australia and the pacific, non -Chinese sources of commodities are being increasingly sought after and on a worldwide basis, even commodities that originate from Australia and are downstream processed in China are losing market share, two is the Australian government's ability to squander money on duds will affect the future, NBN $60bn + French subs $60bn + Snowy Hydro $25 bn + Solar and wind subsidies $ many bn, An out of control and metastasizing "public service" and finally the coming QE to prop up the banks $ ??. Don't sell your bank shares just yet.
Bill Radley
Spot on Marcus. Our plan is to spend it all before we kick the bucket. We have told the kids that anything we leave behind is a miscalculation
Con Compton
Marcus- it’s all very well to say hit the cash button on the super fund's website. Even if you get the timing right and it’s the start of a serious downturn, the fund (mine is CareSuper) takes several business days to act. A lot can happen in that time. In contrast, my investments in funds in the USA held by Schwab are instant.
Marcus Padley
TO BILL RADLEY - "We have told the kids that anything we leave behind is a miscalculation" - Classic - might have to steal that!
Marcus Padley
TO CON COMPTON: I wasn't suggesting you wait for a "Crash" event before going to cash, if that happens we are all caught, I was more pointing out that you can go to cash even in a big industry fund and if at any point you feel uncertain it is an option. Some people don't know they have been left to manage their asset allocation through their big fund. Its a bit of a joke really, the funds have built these websites that have incredibly delegated the one role a fund manager has to add value, the asset allocation decision, to you! They are just administration sites now, avoiding a crash or participating in a bull market is now your decision, not theirs. But their fees remain 'premium'. You might be better off simply buying an ETF over the ASX 200 or one over the S&P 500 and 'slow trading' that making one or two decisions a year or decade to be in or out of the market. Cheaper. Less fees. More control.
Con Compton
Yes, point taken re ETFs. The super fees seem to be extraordinarily high given that we are our own asset managers, especially that some are hidden in the buy/sell spreads when you change asset allocation. How they get away with this is mind boggling.
Bob Horgan
Increasing life spans has created a situation where you need to plan not only for your RETIREMENT years (65-85) and income to support this; but also the capital to support your POST RETIREMENT years (85+) where you may choose to, or be forced to, spend these years in a Nursing Home. Some people go to a Nursing Home by choice (partner has died and they don't want to live at home, services and social support available in the nursing home). Others have no choice (no family support to stay at home, no govt home care package, incontinence or other health issues). Many people live in Nursing Homes for a lot of years, and it costs. If you don't have the initial capital to pay the entry fee you can pay the interest on the fee at 5.96%, there are daily care fees, govt care fee, extra services fees. Any capital will be quickly eroded as most people won't have the income to pay the ongoing fees. You will be very poor before you even reach 100 !
Jimmy Mistry
Marcus, this is a brilliant analysis of things to come. This is one the best articles I have read so far. I do not have $1 million that you talk about so I would be definitely penniless much earlier than my 100th birthday. I have loving and caring kids so I do not share the same fear as some of the others, though I would hate to be dependent on them. I would pray that my life ended earlier, peacefully.
Rod Fraser
Marcus - a great outline. I'm actually ahead of the game - my budget shows me penniless by 85. Suspect I'm not alone.
Robert Delforce
Your usual thought-provoking article, Marcus. However as a senior economist, my thought is: they need to approach their bank to commence a "reverse mortgage" - this is where such a [case study] seniors couple borrow against the equity in their $990,000 home [in this case] to boost their retirement income/living standards = a very simple concept which will solve their money problem WITHOUT recourse to seeking higher returns/yields from higher risk investments!!