Matthew Rady
As record-low interest rates punish cash returns, innovative protected retirement strategies are emerging as a new defensive solution for retirees, states Allianz Retire+.
Key points:
- Term deposit rates have fallen 96% since the 2008-09 Global Financial Crisis (GFC) to just 30 basis points (RBA, April 2021)[1].
- A pre-GFC retiree with $1.25 million in term deposits could have generated $100,000 of annual income. Today, that same retiree can potentially generate only $3,750 of annual income (RBA, April 2021)[2].
- A retired couple today would need almost $21 million invested in cash to fund a comfortable standard of living at the current term deposit rate (RBA, April 2021; ASFA Comfortable standard of living, Dec 2020)[3].
- Protected retirement strategies as an alternative to traditional defensives can potentially provide substantially higher returns than current cash & term deposit rates, with minimal downside risk.
Financial Advisers grappling with record-low returns on cash should consider alternative defensive strategies that can boost returns and minimise risk in retirement portfolios.
Allianz Retire+ research shows, retirees can potentially earn up to seven times the current term deposit rate through a protected retirement strategy, while at the same time limiting their maximum downside to -0.8% per annum[4].
“Retirement strategies that offer downside protection have traditionally been used in the equity component of portfolios to safeguard against sharemarket volatility,” says Allianz Retire+ CEO Matthew Rady. “They haven’t been thought of as an approach that can potentially deliver higher returns than traditional defensive assets.”
Rady says in this environment retirees and their advisers need a new approach to generate returns in excess of cash. “With the cash rate near zero, retirees who have a lot of savings in cash risk going backwards financially in real terms and having a significantly lower standard of living this decade, compared to a pre-GFC environment.”
Rolling over one-year term deposits – a practice favoured by some retirees – is particularly problematic. “Those who persist with this strategy may be in for further pain,” says Rady. “Too many retirees feel there is no alternative and have automatically rolled over their term deposits into lower rates.”
Many retirees favour cash because they want the peace-of-mind that protection and return certainty offers.
The downside in the current environment is minuscule returns. From a high of 8.25% after the GFC, term deposit rates have fallen to just 0.3% (RBA, 6 April 2021)[5]. After accounting for inflation, the real return on cash is negative. (RBA, March quarter, 2021)[6].
“With interest rates at unprecedented lows, and unlikely to head substantially higher anytime soon, retirees need the defensive component of their portfolio to work harder for them,” says Rady.
“They need to ask: how can I get a better return than I’m currently getting from my term deposits or cash, while ensuring there is still sufficient downside protection for my retirement savings? We believe protected retirement strategies that are backed by a life company are part of the answer.”
Rady gives the example of a 68-year-old retiree who inherited $300,000 after the loss of a parent, and wants that money protected and separated from other assets.
If that $300,000 was invested in a term deposit over seven years (from 2014 to 2020), the ending balance would be $353,434, with the cumulative return 17.81%. (RBA, April 2021)[7].
Hypothetically, and using past performance data, had the retiree utilised a protection retirement product, exposed to market linked returns the ending balance on that same seven year period may have been $384,285, with the cumulative return 28.1% (Allianz Retire+ assumptions)[8] excluding taxes and net of fees.
Rady says this case example utilising a 0% protection ‘Floor’ strategy within a 7-year protected retirement product highlights the benefits of incorporating protected retirement strategies into a portfolio, to potentially lift returns in a low-rate environment.
“If an adviser is looking for a higher rate than say a 0.3% p.a return, a maximum potential return of 2.15% per annum on a 0% protection Floor option might be worth consideration.”
Rady cautions that there is a potential limited downside risk involved. Returns are generated from having linked exposure to local and international shares. In the example of using a 0% protection ‘Floor’, if linked markets were to post 0% or negative returns, investors could be subject to a maximum downside loss of 0.8% in a year (Allianz Retire+)[9].“A protected retirement strategy is not risk-free, nor is it a cash or term deposit. It’s a completely different longer-term product, with sharemarket linked returns. We don’t see this as a complete portfolio solution, nor is it a replacement for fixed income in a defensive portfolio. It’s rather one component of a good overall retirement strategy”.
Rady says it’s definitely worth advisers assessing the cash component of their defensive portfolios and assessing a retiree’s risk appetite to alternatives in this environment “if a retiree is prepared to weather a potential downside loss of 0.8% per annum, the flip side potential could be up to seven times the current term deposit rate. That could make a huge difference to returns on part of their defensive allocation over time – and to their standard of living.”.
He believes protected retirement strategies solve several problems. “People in retirement get peace of mind from having downside protection, which is the sense of safety they feel in cash, but potentially a higher return than cash, generated from having exposure to local and international shares. In this market, every extra point of return counts.”
Rady also acknowledges how important financial advice is, particularly when helping retirees navigate a challenging low yield environment. “Financial advice is always important, and especially so when using protection strategies as a component of a defensive portfolio”.-ENDS-
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