Stay the Course
For some people, the perfect financial plan allows them to join the SKI club (Spend the Kids’ Inheritance) and time their departure so that the cheque to the funeral parlor bounces. Others want to leave a legacy for loved ones or some philanthropic purpose. For the vast majority of people, the main aim is making sure their money lasts at least as long as they do.
This issue is becoming imperative. In the 1950s a male could expect to retire at 65 and live to about 67. Today, early retirement (voluntary and involuntary) is much more prevalent and the average life expectancy in Australia is now 83 years old.
This means that a retiree has a 50 per cent chance of living beyond the average life expectancy. A fundamental role of financial planners is to develop a core investment strategy tailored to the goals of the client. However, the real challenge is to ensure the client has the discipline to stick with the strategy and ignore the constant barrage of distracting information. It is important to understand that information is not the same as wisdom.
Warren Buffett, one of the world’s most successful investors, focuses on identifying the fundamental drivers of risk and return for any given investment. His daily ritual does not include the rigorous scrutiny of recent movements in share prices, economic indicators and political gyrations. This is not to say that these issues are not relevant to successful investment, but merely to demonstrate the importance of adopting a longer-term perspective in developing a retirement plan.
Effective use of superannuation is a critical element for ensuring a fruitful retirement. Despite the constant changes to the superannuation legislation by governments of all persuasions, this tax structure still remains one of the most highly efficient vehicles for holding investments, particularly during retirement.
However, one could reach some disturbing conclusions about the average person’s ability to understand and adopt many of the key ingredients required for investing successfully through superannuation. Most Australians do not know the amount being contributed to their superannuation account, are not be able to specify a realistic return to expect from investments and have not reviewed their superannuation account in more than a year.
Furthermore, the majority of Australians have no understanding of how a managed fund operates, much less the nature of the underlying assets held by the fund. Of those that take the trouble to understand the investment process, far too many people base their investment decisions on historical performance. Among the professional investment community this is widely recognized as being the least useful piece of information for making rational forecasts.
Many people fail to appreciate the importance of the big picture, while they chase the latest action or the next big thing. Numerous academic studies have established that more than 94 per cent of the performance of an investment portfolio stems from the asset allocation decision.
Over the longer term, less than 6 per cent of returns are generated from selecting specific securities or timing the market. This is an intuitively logical conclusion given the efficient nature of investment markets. Sadly, it is the lack of investor discipline that causes many portfolios to underperform. A seemingly obvious investment strategy is to buy assets that are underpriced (cheap) and take a profit by selling assets that are overpriced—the straw hats in winter and umbrellas in summer approach.
Yet all too often people do the exact opposite because they make emotional investment decisions based on the state of play in financial markets. It takes a cool head to remain focused on the big picture and nerves of steel to stay calm in a crisis. Smart investors will stick to the path laid out in their financial plan and thereby maximize the chance of achieving their retirement goals.