Be conservative, buy shares

August 16, 2012, 1:21 pm Peter Switzer Yahoo!7

How playing it too safe with your investment strategy can be a wealth hazard!

A guy I know who has been a highly regarded financial educator of financial planners but is now retired, has, like most retirees, a conservative approach to his investments. We always hear that many retirees are camped exclusively in cash or term deposits as they are sick of the stock market, but my mate, who is very conservative, is 90% fully invested in shares!

The chart

My mate has a self-managed super fund (SMSF) and when he explained his investment strategy, which by law has to be written down with a SMSF, he used a chart showing comparative returns on $100,000 invested over 1980 to 2011 to explain his stance. This is a pretty fair time period to look at as it has at least three market crashes — 1987, 2001 (the dotcom crash) and the global financial crisis (GFC).

The chart he showed me had both the income or dividends and the capital gains or losses over those years for industrial stocks and term deposits. Being $100,000, the interest oscillated with changes in world interest rates as well as the Reserve Bank’s decisions and those of the banks. As rates went sky high in the 1980s, interest on a $100,000 term deposit went up to around $15,000 or 15% but over most of the period it was around 6%.

Do the maths

The capital value of the deposit remained at $100,000 as you would expect and I should throw in that I’m leaving out inflation, which undermines the real value or the purchasing power of the $100,000.

On the other hand, the income or dividends from $100,000 in industrial stocks was around $20,000 or so in the 1980s, and went to the $30,000s in the 1990s. It then spiked between 2000 and 2011 from $40,000 to a high of near-$80,000 in the 2005-07 period before sliding back to $60,000 post-GFC.

Meanwhile the capital value of the $100,000 shares went to a high of around $1,800,000 in 2008 before falling to $1,400,000 in 2009 and then rebounding to close to around $1,600,000 by 2011.

Sure my mate’s nest egg might have lost $400,000 thanks to the GFC but it started as $100,000! And it did peg back $200,000 after the worst of the GFC. More importantly, look at the dividends it kept delivering — a high of $80,000 but something between $60,000 to $70,000 even post-GFC!

Shares vs. property

One interesting aspect of my mate was that he believed in shares more than property and so he has always been a renter. When he retired, he had about $5 million in his super fund, though he did buy an apartment for cash when he stopped working. As a part of his retirement strategy, he had 10% in cash to ride out a couple of bad years so he would not have to eat into his nest egg or lump sums.

He also constructed a portfolio of about 20 stocks made up of some of the best companies in Australia including the banks, Telstra and other renowned dividend-paying stocks. He believed that history showed him that with these kinds of stocks, with franking credits and the tax-free status of his super in retirement, he could expect a 10% return on his invested money, or $500,000.

Of course, some years that could fall to, say, $300,000 but in other years it could be greater. If the dividend flow averaged 7%, he and his wife would have $350,000 a year, which would fund a great retirement — no, an unbelievable retirement.

Be prepared

He argues the biggest risk is not a bad stock market which can hurt your nest egg but you living too long and running out of money. That’s why he has two years of cash so he never has to eat into his capital.

He also makes the point that their life is generally very good, but if a tough time emerges, they tighten their belts and live relatively frugally, say on $200,000 instead of $500,000!

Another example

Now I know the point I make is excessive because my mate was a star performer and he amassed a massive lump sum but let’s take his story down to normal people standards.

If a couple retired with $500,000 in their super with their house paid off, they could create a solid dividend-paying portfolio and say average an 8% return, which could deliver $40,000 a year. With access to a part pension, it could push their annual income well over $50,000, which the Association of Superannuation Funds of Australia (ASFA) argues gives retirees a “comfortable life” in retirement.

Seek experts

I sometimes worry about retirees who are scared of the stock market and have gone too cautious, which means their nest egg will shrink as the years go by and while they have peace of mind now, they will really struggle if their health is more robust than their super.

I think my mate’s story is the strongest case for individuals to get some professional advice to help them with their investment strategy because playing it too safe could actually be a wealth hazard!

Peter Switzer is the founder of the Switzer Super Report, a newsletter and website for self-managed super funds.

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