Recommended: income solutions
Big super funds have been grappling with strategies for their growing numbers of retirees for many years now. And it is not easy. In the first of a four-part series, we discuss how to cope in the current low-interest rate environment. It’s all about inflation protection.
Legg Mason, the global multi-affiliate manager with a strong Australian presence, says in a white paper, ‘Income Investing in a Low Interest Rate World’ that, for investors to be able to maintain their spending power and to protect, as well as maintain, their living standards they must ensure their income stream grows at least in line with inflation.
This is particularly important for people as they enter retirement, when they are likely to incur increased costs in areas such as healthcare. Australians are living longer. So, money is a big – and getting bigger – issue.
In a world with historically low interest rates, which may be good for borrowers such as home-buyers but a real problem for people who depend on regular income streams, the issue is compounded.
For instance, the paper points out that, in 2010, one of Australia’s leading banks offered its customers a five-year term deposit rate of 8 per cent. Today that same bank is offering less than 3 per cent on a five-year term deposits and a little over 2 per cent for a more popular 90-day term.
“The steady fall in interest rates over the past seven years has exposed investors to heightened income risk and inflation risk – the risk that the real value of an income stream declines as the cost of living rises. As seen in the chart below, living costs have continued to rise as term deposit rates have continued to fall,” the paper says.
Legg Mason’s research shows that, over the past 20 years, a retiree’s income needed to grow by 63 per cent just to offset the loss of purchasing power due to inflation.
So, the paper looks to dispel two myths. They are:
- Hidden volatility: focus on the income stream. The advantage of term deposits and fixed annuities is that they do not have the capital volatility of shares. But the reality is for an income investor the volatility of the income stream should be the first concern. The income generated from an investment in the share market will outstrip what would have been received from a term over most periods.
- Term deposits and annuities are not the only solution. The basic concept of an annuity is that it provides the investor with a secure income stream for a specified period of time. The capital is protected, providing the investor with apparent peace of mind. The reality, however, is that an investor can pay a high price for ‘peace of mind’.
“Relying solely on a term deposit or annuity to deliver a sustainable income stream is not realistic due to current low interest rates and the ongoing risks associated with these types of solutions. As with any investment strategy, a balance of different assets, approaches and styles is optimum in meeting desired outcomes,” the paper says.