In the financial and economic world, we use medians and averages to assess our position and make decisions about the future. Over the last month, some experiences with clients have led me to question which statistics are useful and which may be obscuring reality for many.
Taking on debt
According to RP Data, the median price of homes across Sydney increased by an average of only 2.5% a year over the 10 years to July 2013. This figure is used to refute claims that we are in a housing boom. However, a client told me she had been offered $920,000 for her home in Petersham, in Sydney's inner west, just six months after being offered $850,000. Another client has just bought the house next door in the inner Sydney suburb of Alexandria for $800,000, two years after buying their similar home for $600,000. Clearly, 2.5% is not a good measure of what’s going on in many parts of Sydney more recently.
An estimated two-thirds of households have no mortgage debt (half of these are renters) and of the third that do, most are well ahead in repayments. A client has just refinanced her home loan with her new partner. The property was purchased for $1.2 million using a loan of $800,000 with a 30 year term. It’s a big loan, she told me, but they both earn substantial salaries and can comfortably service the repayments.
The problem is that these clients are 54 years of age. Does the bank expect them to work and maintain their high salaries till they are 84? The alleged safety valve that ‘most people are well ahead in repayments’ is nonsense if this sort of practice is widespread. Perhaps the bank expects the repayment will eventually come from superannuation proceeds or downsizing, or if necessary, the bank can repossess the property and hope to sell for more than the borrowed sum.
On Saturday, I asked a mortgage broker friend how many loans like this are being written. He told me that it was common, but he didn’t seem too fazed by the practice. It appears that the average tenure of a home loan is only four years, so repayment of the loan is likely to end up as another bank’s problem. Another broker said that banks are not supposed to write loans unless there is a clearly identifiable exit strategy whereby the mortgagee is not compelled to sell their house.
Large super balances are in the minority
Unfortunately, cashing out super to pay off debt appears to be an acceptable exit strategy. A report published by CPA Australia in August 2013 identified that this was an all-too-common experience. Data from the Association of Superannuation Funds of Australia (ASFA) shows that the average superannuation balance for a male aged 65 to 69 is just $77,000, and for women it is only $55,000. If many of the households that have eliminated mortgage debt have done this by cashing out their super, then this statistic is hardly cause for comfort.
The Australian Financial Review had a front page article on 12 October 2013 claiming that there was a surge in baby boomer retirement. The implication is that with average net assets close to $700,000, boomers were happily exiting their jobs for a life of overseas travel and playing with the grand-children. Anecdotally, my experience is that for every boomer client who is smelling the roses, there are another four working for low pay in places like Coles and Bunnings. The CPA survey revealed that the average net wealth of retirees aged between 60 and 69 is $987,000. This statistic is being used to illustrate how wealthy we are, but $598,000 of this is tied up in property. It’s not much good having a net worth of close to $1 million if most of it is the value of your home when you retire, and you face the prospect of creating sufficient money to live on for 25 years without employment income.
Major differences between sectors
Let’s look at the share market. The performance of the S&P/ASX200 is a weighted average of the returns from the top 200 companies listed on the Australian share market. The price index (ignoring dividends) is still about 30% lower than in 2007. Yes, you can study price/earnings ratios and come to the conclusion that the share market looks like reasonable value. But P/E ratios are usually based on future expectations that may not eventuate, and to say that the market is 30% below its 2007 level is disguising huge differences. Shares in CBA are trading at record highs, while the price of BHP Billiton has fallen by about 22% from its $48.70 peak in 2008. How much joy clients are receiving from the market depends on what they own.
I recently had a visit from my auditor for our annual check-up. “How are your clients doing,” I asked. Given that unemployment had recently fallen to 5.6%, and business and consumer confidence was rising, I thought he would be quite positive. “Terrible,” he said. “Most small business revenue is 40% to 50% down.” He explained that the choices facing small business people are not good. Either they close down with debts they can’t pay back, or they keep going in the hope that things will pick up. In the meantime, they pay themselves less and less, and they still have to pay minimum wages to their staff.
You only have to drive down Parramatta Road or Oxford Street in Sydney to see how small business is struggling. We also know that many people have given up looking for work, and the fall in the participation rate disguises underemployment. Many are working fewer hours than they would like or for less money. The unemployment rate is another questionable statistic we use to measure the strength of the economy, but we need to factor in these reality checks.
Expect the unexpected
People approaching retirement should make sure that if things go wrong they have an exit strategy. It means making sure they can achieve short, medium and long term goals. It means diversification and risk management. It means that they cannot afford to be complacent. To quote Tim MacKay of Quantum Financial on using all your super to gear into property: “As long as property prices go up forever, interest rates stay low forever and you never lose your job, there is no risk with this strategy. Good luck with that.”
Rick Cosier is a financial adviser at Healthy Finances Pty Ltd.