SMSFs prime candidates for sequencing risk

SMSF investors on average are older, wealthier and exhibit far more control over their decisions than others in the superannuation industry, which also makes them more susceptible to the impact of early losses on their retirement funds.

Financial risk management firm Milliman has conducted a high-level analysis, running thousands of simulated scenarios using a simple portfolio to replicate the average SMSF based on clients of administrator Multiport.

“This analysis shows that a typical SMSF portfolio has a one in 12 chance of experiencing a double-digit drop in the first year – at least 10 per cent compared with the expected consumer price index plus 4.2 per cent – which would strip eight years from a pension,” Milliman head of fund advisory services Michael Armitage revealed.

“The impact of an even larger 20 per cent loss causes the nest egg to deplete 12 years sooner.

“This is sequencing risk in action – the heightened risk that an investor with a large balance approaching retirement, or in retirement and drawing down a pension, faces.”

Armitage noted younger investors had time on their side.

“They are often making contributions, rather than withdrawals, and can benefit from an eventual market rebound,” he said.

“Older investors don’t.

“If our investor lost 10 per cent in the first year of retirement, he would need to outperform inflation by 5.9 per cent a year for the subsequent 29 years, as opposed to the original target of inflation plus 4.2 per cent, to make up for the impact of the downturn.

“Alternatively, he would need to reduce his lifestyle by cutting down withdrawals or face running out of money.”

The challenge faced by older investors and retirees remained the same, he added.

“They need growth to fund their increasing lifespan, but can’t tolerate substantial volatility or losses,” he said.

“While many SMSF investors hold significant cash rather than bonds, interest rates remain at historic lows.

“Constructing sound portfolios which can manage heightened risk while delivering returns is a key challenge – explicit risk management strategies that include capital protection utilising simple exchange-traded instruments are a new but effective part of investors’ toolkits.”

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