Talk of a recession and underlying unemployment continuing to head north of the 7.1% official rate won’t be allaying the feelings of uncertainty we’re all feeling at the moment, including those nearing, or in, retirement.
While the situation this time around is different to recessions of the past, and the GFC, the need to understand risk tolerance and financial strategy in managing retirement nest eggs is more important than ever.
Differences to the 80s recession and GFC
What drove the economic downturns in the early 90s and GFC were very different to what’s driving this downturn. In the early 90s, the economy was facing growing levels of debt, high interest rates and high inflation, while the GFC was brought on by low interest rates fuelling irresponsible lending in the US housing market, which then went bust. This time around, it’s been an external shock in the form of COVID-19 that has led to the downturn.
However, the impact might feel similar to the early 90s recession, with rising unemployment being one of the most obvious consequences. But the main industries affected this time are different, with tourism, hospitality and education bearing the brunt.
The Government’s response
The Government’s response to the current downturn has also been very different. In the 90s the government cut tariffs, reformed industrial relations and looked to productivity increases and globalisation to bring about economic recovery. While this time it feels like almost the opposite with a shift away from globalisation possible.
We’ve seen a lot of intervention by governments and central banks, which we also saw in the GFC, although it has happened much quicker in the COVID-19 downturn.
Central banks, such as the RBA, would typically cut interest rates to stimulate economic growth but with interest rates already at record lows they’re instead buying assets, such as bonds.
This strategy, known as quantitative easing, means there’s a lot of extra money flowing into investment markets, which is causing prices in investment markets to go up, leading to a widening gap between the underlying state of the economy (which is trending downwards) and asset prices (which are trending upwards).
The impact on superannuation and investments
Due to quantitative easing, asset prices are likely to continue to go up – which is what we’ve been seeing in the share market – despite the negative economic outlook. This will probably continue over the short-term, but in the long-term it creates a new risk in the system. Instead of concerns about the level of household debt or corporate debt there are likely to be concerns about the level of government debt.
So, the long-term outlook is a bit riskier, as the reality of the underlying economic situation could kick in at some point if financial markets lose their confidence in the central banks. Total long-term returns are probably going to be lower than they’ve been in recent cycles.
Considerations for new and pre-retirees
A lot of people have had their super in a growth option, which is usually fine over the longer term, but in or nearing retirement the focus should be on how to achieve a stable income stream rather than the accumulation of capital.
For those nearing retirement, a substantial capital loss now could have a big impact on lifestyles. It’s extremely important to understand risks and the impact these could have on retirement outcomes. These things should be considered if someone is thinking about deferring retirement until their super levels have been restored.
For those already retired, expected spending should be re-visited as budgets will need to be reassessed for the next five to 10 years. Because financial market conditions have changed, investment strategies should also be reviewed to understand the changes to expected returns and income, as well as the changes in the level of risk being faced, and whether there is comfort in carrying this risk.
As always, and particularly due the vulnerability of finances at this time of life, it always makes sense to speak to a super fund or financial adviser before making any changes to superannuation or investments.
Lakshman Anantakrishnan is Chief Investment Officer, AMP Australia