I frequently join James Kirby on his bi-weekly podcast hosted by The Australian newspaper. Recently, he delved into the interesting and important topic of “how much money you should have in superannuation.” I couldn’t resist the temptation to share my thoughts and insights.
How long will retirement last?
I read this article by Ashley Owen with great interest. He highlighted three potential shortcomings with life expectancy tables (these tables predict how long you may live).
- Life expectancy figures represent the median, meaning that 50% of individuals actually live longer than the age stated.
- Owen pointed out an interesting trend: life expectancy has increased by two to three decades over a person’s lifetime. For example, when my father was born, his life expectancy was 66 years. Today, it’s 82 years—a remarkable 24% increase. This shift is largely due to advancements in preventative medicine, improved medical treatments, and better health education. Considering the impact of technologies like AI, it’s intriguing to ponder how life expectancy might evolve in the future.
- Personal factors such as health choices, fitness levels, lifestyle, diet, and genetics play a significant role in determining individual life expectancy.
The reality is that many readers of this blog are probably likely to live beyond 100 years of age.
Shortcomings with super retirement calculators
Retirement calculators help you figure out how much super you’ll need or how long it will last. It’s crucial to use them wisely and understand the assumptions they’re based on. Some calculators use very low living expense estimates that may not be appropriate for you. Additionally, many assume you’ll deplete your super balance completely, which doesn’t account for the risk of living longer than expected. The most effective calculators let you set your preferred living expenses as a benchmark (like this example).
A perpetual portfolio means you never need to worry
The ideal scenario is a perpetual portfolio, where your capital remains intact despite withdrawing funds for living expenses. Essentially, it means your investment returns – both income and growth – exceed what you need to live on. A perpetual portfolio ensures you can sustain your lifestyle indefinitely because your capital remains intact.
The beauty of a perpetual portfolio is the peace of mind it offers. That is, you’re protected against the risk of running out of money. Even if unexpected costs arise such as medical expenses, or living expenses increase, as I recently discussed, you can rest assured knowing your retirement funds will be more than sufficient.
How to achieve a perpetual portfolio
There are two prerequisites to achieving a perpetual portfolio.
Firstly, your initial investment base (the value of your assets) must be sufficient to generate total investment returns that exceed your living expenses.
Secondly, your asset allocation needs to be appropriate for achieving your desired long-term returns. Traditionally, retirees typically reduce investment risk by allocating more to defensive assets like cash, bonds, and infrastructure. However, this conservative approach typically yields lower long-term investment returns. In contrast, with a perpetual portfolio, it may be appropriate to take on more risk by increasing your allocation to growth assets, if it aligns with your risk tolerance. This strategy aims to maximise long-term returns to maintain your capital, as illustrated in the case study scenarios below.
If you have a higher allocation to growth assets in retirement than usual, it’s crucial to keep at least 2 to 3 years’ worth of living expenses in cash. This approach prevents the necessity of selling growth investments during unfavourable market conditions, such as in a market crash scenario.
Scenario: Super only
I’ve calculated that beginning retirement with $2.75 million in super will allow you to spend $120,000 annually on living expenses (adjusted for 2.5% inflation each year) whilst keeping your super balance around $3 million in today’s value. By the time these retirees reach 100 years old (in 40 years), their super balance will grow to approximately $9.3 million, which is equivalent to $3 million in today’s dollars. This means they’ve effectively preserved their capital in real terms.
My calculations assume keeping 3 years of living expenses in cash, earning 3% annually, and investing the rest in growth assets with an average return of 7% p.a.
Scenario: Super and property
I considered another scenario involved using a combination of an investment property and super to fund retirement. The strategy involved using super to fund the initial 15 years of retirement, while holding onto the investment property longer to benefit from its compounding growth over time. After 15 years, the property would be sold, and the after-tax proceeds would then fund the remaining 25 years of retirement.
In this scenario, I assumed a starting super balance of $1.6 million. The investment property was valued at $1.5 million, with an $800,000 loan against it and $300,000 in the offset account.
You’ll notice that in the first 15 years, investment returns exceed living expenses because it includes the investment property’s capital growth. However, after selling the investment property, the investment returns eventually become less than the living expenses, meaning the investors eats into capital. I project the investor will have $18 million of investment assets by age 100, which is equivalent to $670,000 in today’s dollars.
Holding the investing property has played a very important role in the scenario – it has underpinned super and ensured the retiree will not run out of money.
So, how much super should you have?
The first decision you need to make is how you’ll address longevity risk. Is your goal to have a perpetual portfolio, or are you inclined to mitigate the risk of depleting your super by holding onto other investments like property? Alternatively, are you comfortable with the possibility of exhausting your investment balance by a certain age?
Secondly, depending on your chosen approach, you need to work out what investments you must make (e.g., property, super and/or shares) before you reach retirement age. If super won’t be sufficient, then you must invest in other assets.
