Superannuation is in the news yet again! This time it’s a major report from the Productivity Commission containing a raft of recommendations to make more changes to the system.
Predictably, it got great headlines. After all who could resist the “revelation” that an employee who is young today could be more than $500,000 better off at age 65 if they chose a better performing fund than someone who chose a lesser one?
But that’s no revelation — it’s just the way compound interest works. For example, if a 21-year-old was earning $35,000 a year and their salary increased by 4% per annum they would have $2.2 million at age 67 if their fund achieved 9% per annum. If another person in the same situation got only a 4% return, their balance would be just $800,000.
So, it’s stating the obvious to reiterate that the biggest factor in your retirement superannuation balance is the net rate of return you can achieve. The major factors that affect that rate of return are the performance of the assets you choose, the fees your fund charges, and other expenses, such as insurance and entry taxes.
The impact is particularly high for young people. Imagine you were 21, with a superannuation balance of $3000. If your insurance premiums were $100, and account-keeping fees were $100, your net return would be close to zero if your fund earned 9%. The only thing keeping you out of the red would be the employer contribution, which may be around $3000 a year after the government hit you with the 15% entry tax. But contributions, even though they increase your balance, have no effect on the return from the fund.
A major problem for many younger workers is that most of them are disengaged, and as a result have multiple superannuation funds with small balances. The combination of all those account-keeping fees, and of premiums for insurance (which is often unwanted), is ripping their returns to shreds.
The obvious solution, and the Productivity Commission alluded to it, is to have some mechanism where small multiple balances owned by the same person would be compulsorily amalgamated and placed in a default fund. At least this would go some way towards boosting their returns.
Then there’s the problem of choosing an appropriate fund. There is no easy answer, because an appropriate fund will vary according to the individual’s risk profile and goals. Either seek advice or do your research.
The Commission has tried to assist with this problem by recommending the government set up a panel of Best in Show which would comprise the best 10 performing funds over the last 10 years. Employees would then be nudged towards using those funds, in the expectation they could do better than the funds they are using now.
But the whole concept is based on flawed logic. The ASIC website is unequivocal. It states that advertising of financial products and advice “should ‘unambiguously and without reservation’ point to the fact that past performance is not indicative of future performance”.
For as long as I can remember, the financial planning industry has been warning investors that past returns do not necessarily guarantee what may happen in the future. But here we have the Productivity Commission recommending a change in the system based on the premise that past returns should be the major criterion in the fund you choose. It beggars belief!
The sad reality is that governments can only do so much. At the end of the day it’s up to individuals to become engaged with their own financial affairs, to make sure they are making the most of their precious resources. There is no other way to make it to a prosperous retirement.
- Noel Whittaker is the author of Making Money Made Simple and numerous other books on personal finance. firstname.lastname@example.org