The Super Solution.

Background.

There are three foundation stones to investing. For simplicity let’s call them Saving, Structure, Rate of Return. There are three major expenses in your life you will need to save for over a period of many years. Your House, The education of your children and your retirement. The Australian government recognised that for most people saving for their retirement while they had the pressure of living and the costs of a mortgage and school fees was just too much. To help you achieve the aim of a happy and bountiful retirement they set up the present Superannuation system. It ticked all the boxes. The saving was mandatory, the structure allowed for a 15% tax rate so all you had to do was get the return. Unfortunately, that is where it fell down, the returns.

Over the last 40 – 50 years the Australian stock market has returned 11.4%, that is 9.7% after tax. 

30 years ago when Super started the average house in Australia doubled in price about every 8 Years, which works out at 8.7%. On top of that you could get a net return of 2 -3 % from the rent. 

For the 20 years prior to 1992 when compulsory Superannuation began the average interest rate was about 10%, it had been much higher over the previous 10 years. 

It was perceived that there would be little problem for a Superannuation fund to make a return of 8.5 – 9.5% to the superannuant net of fees and taxes. That sort of return would complete the trio of foundations stones and put the average worker into retirement with a nice balance that wouldn’t require the government to chip in with a pension.

Almost from day one the wheels fell off the system.

Housing

The Capital Gains Tax was implemented in 1985 and had been around for 7 years at the start of the Superannuation program. For the first few years it worked on a system where the capital gain was effectively looked at as income and taxed accordingly. This system was an administrative disaster and the present system took its place. The biggest problem was that there was no CGT on a principle place of residence. That meant that a whole generation put a lot of their savings into residential housing to avoid tax, forcing the price of residential real estate up. 

To compound the problem the GST came into effect in 2000. This resulted in State Governments looking for new sources of revenue, which they found in Stamp Duty on housing and Land Tax, to the point where the State Government takes about one third of the cost of a new house.

The result is that residential real estate is no longer a decent investment.

Interest Rates.

From 1992 until 2008 interest averaged around 6%. After 2008 they have declined to the lowest levels ever recorded.

The result is that you can no longer afford to have significant percentage of your superannuation in cash.

Equities.

While the volatility of equities has increased especially around the GFC and COVID-19 the market has increased at about 5% Capital and 5.5% dividends over the last 28 years.

Administration.

A series of legislative changes has dramatically increased the cost of administration for Super Funds. It is no longer feasible to run a mid sized operation. You either must be in a SMSF or a huge corporation.  Like all business in Australia it is all skewed towards a few major players as they buy up the intermediate sized operators.

Corporate Superannuation Funds.

To fulfill the regulatory requirements of the Superannuation Industry large corporate entities have outsourced a significant number of processes, including fund management, custodian services, administration, and strategic development.

This has lead to a build up of fees and sometimes fees on fees. 

A simple example. You own a balanced fund with a Super Corporate who is charging you 1% of the capital for administration. This corporate then outsources its fund management to an entity that has a balanced fund holding 25% in cash and charging a 1% fund management fee. Effectively you are paying 2% in fees for an investment that is returning 2% on cash.

Present Position.

While the savings regime and structure are in place it has become extremely hard for the average Australian to achieve a satisfactory retirement through larger industry and retail superannuation funds.

The Answers.

There appear to be three answers to the problem, which by the way is that 80% of retirees receive a full or part pension.

Stop the System.

Many believe that stopping superannuation would increase the income tax to a level where the government will be able to fund a pension for all but a few.

Increase the Level of Savings.

It has been legislated that the level of savings be increased from 9.5% to 12%. This would mean taking more money out of your pocket now for a better retirement.

Increase the Returns. – the present

Over the last 30 years the Australian Equities market has returned over 11% annually, but Super Funds have managed only 6 – 7%, where is the difference?

Cash.

Firstly, many funds are required to hold significant amounts in cash. This is doubled down on when the fund manager buys an investment that is also holding a lot of cash. For example, at present many of the investment funds are holding large amounts of cash. I know one that is holding 44% cash, but the average is more like 15 – 20%. If you are in a balanced administrative fund that is holding 25% cash, then effectively you are holding around 40% in cash.

Fees.

The average administrative Super fund charges about 1%, but that is just for the administration of the fund. On top of that you also pay, investment fund managers and custodians. Even more is that investment fund managers buy shares in equities that are managed and have fees. You can end up paying between 3 – 4% in total fees.

Investments in real estate go through the administrative Super Fund, a real estate fund manager, and possibly a REIT or private equity entity. All charge their fees.

Wrong choice of fund.

Most people do not understand their risk profile and therefore end up in low risk funds with extremely poor returns in their early years when it really counts. This is an issue of lack of education.

Increase the Returns – The Answer.

There are four elements to the answer.

Self Managed Super Fund. – SMSF.

You need to have a SMSF where the fees on a balance of $300,000 are about 1%, but on $500,000 they are about 0.6% and on $1mill are about 0.3%.

Be Your Own Fund Manager.

There are a myriad of investments out there returning in the order of 11% after fees.

Do Your Own Administration.

For a simple fund this can take as little as 10 hours a year. In 1997 Harvard Business School did a survey of the CEO’s of the Fortune 500 companies. The average CEO spent 20 hours a year on their own financial affairs. 

Keep Your Eye on the Scoreboard.

You only need to spend a couple of hours a month. It has been statistically proven that measuring performance will increase that performance. 

Hurdles.

Getting to $300,000.

In my experience the average 20 year old has parents about 50 years old. The average 50 year old has looked at their super about twice in the previous decade but on turning 50 all of a sudden realise the $350,000 they have in their super fund is not going to give them the retirement they require.

There are two ways the 50 year old can go. The first is to realise they will spend their retirement on the pension, so they carry on as before and when they get to retirement, they spend the excess over their cap having a good time. The second is that they can supercharge the last 15 years of their accumulation phase by taking their $350,000 out of a poor performing large fund and do the investing themselves and get a much better return.

The objective for you is to convince your parents to start a SMSF which you can join making the fee structure worthwhile. Now I did run this by the senior manager of my Super administrators, and they laughed. The answer is most parents want to spend it. The thing that surprises me Is that a whole generation of helicopter and bulldozer parents will do anything to protect their children from the world, but they won’t help them achieve their dreams.

Getting the Courage.

Taking control of your super is not that difficult. The main hurdle is your perception of your own ability. Nearly every child can remember standing on the end of a diving board or pier and wanting desperately to jump off, but just can’t summon the courage. Then they get the courage and jump. Straight away they are up there again to have another go. The sun goes down and their parents have trouble getting them home. The question is how you gain the courage to jump the first time.

Many times, the answer is in incremental change in the size of the jump.

Step 1.

Open an online trading account. Save some money and start investing. I know many that think they can do it with a virtual portfolio, but you must remember that the pain of losing money is three times the joy of making it. Your first aim should be to get 5 stocks of about $1,000 each. Save some more money buy some more stocks. In about 2 years you will be like the kid jumping off the end of the local pier. 

This is best done in conjunction with your parents so that they build the courage to swing their super out of their poor performing fund. You and your parents must have the confidence you can perform better than the Australian Super system which is rigged against you.

Step 2.

Develop a trading strategy, remembering there is a difference between investing and gambling. I can’t give advice to anybody, but I would say that your job is more one of human resources rather than actual investing. There is a myriad of fund managers out there in many different areas. There are some with exceptionally low fees, less than 0.2% that have been producing great returns for over 50 years. There are some with higher fees but also high returns and of course more volatility. 

Your job is to find the fund managers that suit your risk profile and then work with the managers. 

Step 3.

Set up your family super fund. Depending how much your parents have they may not have to move all of their fund across in the first instance.

Step 4.

Get all the members involved and take responsibility for your own money. 

If the Parents will not Play.

There are other options for getting the $300,000 together.

A put together a group.

This can be a disaster but that’s better than the odds of the status quo.

Put the hard word on the grandparents.

Grandparents that have more than $300,000 in their super can move some across to a new fund and include you in that fund.

Superannuation and Intergenerational Wealth.

The government has decried the use of Superannuation for Intergenerational wealth transfer. While commentators have analysed the use of Superannuation as a method of transferring wealth to the next generation there has been little research into where that wealth goes.

It is my contention that a substantial majority of that wealth ends up in the residential real estate market. I have spoken many times that this wealth is moved from income producing assets to lifestyle capital.

The issue is that in trying to increase the percentage of self-reliant retirees we are trying to break the laws of nature and the theory of the Pareto Distribution.

Being an eternal optimist, I believe that can be done, at least in the short term.

Imagine if the capital of a superfund was distributed to beneficiaries on the death of the holder and treated as income and therefore taxed at the marginal rate of the recipient.

If it were to go to an individual it would most likely be taxed at 47%, but if it went into the individuals super fund it would be taxed at 15%. Obviously those with more wealth could feed it through a discretionary trust where children and grandchildren could have their super funds topped up ensuring they were never on the pension or even part pension.

Summary.

The Superannuation system in Australia, like most good ideas, had good intentions but has become the cash cow of not only the large superannuation funds but also a lot of fund managers. $3trill in Super is paying a minimum of $90bill in fees, the result is that it is not achieving its objective of funding people in retirement. There are answers but they require individuals to take responsibility for themselves, educate themselves, do some work and reap the rewards. 

While this approach is not likely to have widespread uptake, I believe there is a great opportunity for the Centre for Self-reliance to work with parents, grandparents and service providers to show how a self-reliant model can achieve the desired results.