Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 311

How important are investment costs for retirement?

Retirement is complex, and in spite of the volumes of research on the topic, there are rarely simple answers to many questions for those moving into retirement.

Detailed planning around goals, risks and financial resources is critical to manage a long retirement, and a lack of sufficient planning makes retirees financially vulnerable to the risks of outliving retirement savings, overreacting to market volatility, holding inappropriate portfolios and being unprepared for unexpected costs.

The one item that can be controlled is often overlooked

There is however one simple concept that is universally true when it comes to choosing an investment product. It is more important than ever when you are in the drawdown phase. That is, all else being equal, a lower cost product will produce more retirement income than a higher cost product.

Think about that for a second. We spend a lot of time as investors looking for ways to increase retirement income, and one of the easiest ways is often overlooked.

To illustrate how important costs can be, we have looked at income from both the age pension and superannuation drawdown, and the amount a retiree can spend in real terms each year for 30 years with 95% certainty, and we compare two cost scenarios. The first assumes that the retiree is invested in a high cost product charging 1.5%, and the second is a lower cost product charging 0.5%.

The differences are striking.

A single retiree with a $400,000 superannuation balance at retirement can spend over $1,600 (a 4.5% increase) more per year, adding up to more than $48,000 over the course of their 30-year retirement, if they use the lower cost investments (all else equal). For a couple with a combined $800,000 superannuation balance, they can spend more than $2,800 (a 5.0% increase) more per year, or over $85,000 total, when using lower cost solutions.

Source: Vanguard, June 2018 Vanguard Capital Markets Model Simulation. See Note 1 below for more details.

The importance of fees increases with wealth

Driven by the higher dependence on superannuation to meet income needs, those retiring with superannuation balances over $1,000,000 will find their sustainable annual retirement income increases 6% to 9% when using lower cost products versus higher cost products.

A key question, always top of mind for those saving for retirement, is ‘How much is enough’? Or how much do they need to save to be comfortable in retirement.

There are many complex planning elements involved in answering that question, but the universal truth on controlling costs still holds.

Assume a couple planning for retirement would like to spend the ASFA Comfortable Retirement Standard ($60,604 in real terms) for 30 years and would like to see the wealth needed to meet that goal with different probabilities of success.

Again, we have incorporated both the age pension and superannuation drawdown, and we look at the superannuation balance needed to meet this income objective with 50%, 75%, and 95% probability while paying low (0.5%), moderate (1.0%), or high (1.5%) costs.

Focusing on the 95% probability, we see that roughly for every 50 bps increase in costs, the couple needs an additional 10% in their superannuation to meet their goal, and comparing the high cost 1.5% scenario to the low cost 0.5%, we can see a difference of $167,000 ($977,000 versus $891,000) in wealth needed to meet the same objective.

Source: Vanguard, June 2018 Vanguard Capital Markets Model Simulation. See Note 2 below for more details.

All costs cannot be avoided

Investors will almost certainly need to pay some investment costs for a quality product, with some choosing to pay higher fees for the prospect of outperformance, and there is more to investing than costs alone, such as the value of quality financial advice.

But in the end, cost is one of the few things you can control and keeping an eye on costs is a great way to boost your retirement income prospects.

 

Notes on charts

Note 1: The income levels shown are based on a constant real spending amount over a 30-year horizon with a 95% probability of success. Retirees are homeowners with a balanced (50% equity/50% bond) portfolio. The model incorporates the age pension as at 20 September 2018 and only considers financial wealth and therefore does not consider assets that would not be deemed to earn an income (i.e. home contents) or additional income (i.e. employment income) which would shift eligibility. The model treats superannuation and non-superannuation assets as one pool of financial assets and therefore we have assumed that any minimum withdrawals from super that exceed the retirement income targeted are reinvested in a non-super account. All values are in real terms. The examples used here are general only and do not consider any personal information. Actual age pension received may differ from that represented by the analysis due to a range of legislative and personal factors. The projections or other information generated by the Vanguard Capital Markets Model (VCMM) regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. Distribution of return outcomes from the VCMM are derived from 10,000 simulations for each modeled asset class in AUD. Results from the model may vary with each use and over time.

Note 2: The ASFA Comfortable Retirement Standard as at June 2018 is $42,953 per year for a single and $60,604 per year for a couple. We have assumed 0.5%, 1.0%, and 1.5% annual investment fees, the retirees are homeowners and a balanced (50% equity/50% bond) portfolio. The model incorporates the age pension as at 20 September 2018 and only considers financial wealth and therefore does not consider assets that would not be deemed to earn an income (i.e. home contents) or additional income (i.e. employment income) which would shift eligibility. The model treats superannuation and non-superannuation assets as one pool of financial assets and therefore we have assumed that any minimum withdrawals from super that exceed what is needed to meet the ASFA retirement standard are reinvested in a non-super account. A non-homeowner would need to consider rental costs in addition to the Retirement Standards. All values are in real terms. The examples used here are general only and do not consider any personal information. Actual age pension received may differ from that represented by the charts due to a range of legislative and personal factors. The projections or other information generated by the VCMM regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. Distribution of return outcomes from the Vanguard Capital Markets Model (VCMM) are derived from 10,000 simulations for each modeled asset class in AUD. Results from the model may vary with each use and over time.

 

Aidan Geysen is Head of Investment Strategy at Vanguard Australia, a sponsor of Cuffelinks. This article is for general information purposes only and does not consider the circumstances of any individual.

For more articles and papers from Vanguard Investments Australia, please click here.

RELATED ARTICLES

Achieving a sufficient retirement income portfolio

In fact, most people have no super when they die

There’s a lot more to retirement incomes than super

banner

Most viewed in recent weeks

10 reasons wealthy homeowners shouldn't receive welfare

The RBA Governor says rising house prices are due to "the design of our taxation and social security systems". The OECD says "the prolonged boom in house prices has inflated the wealth of many pensioners without impacting their pension eligibility." What's your view?

House prices surge but falls are common and coming

We tend to forget that house prices often fall. Direct lending controls are more effective than rate rises because macroprudential limits affect the volume of money for housing leaving business rates untouched.

Survey responses on pension eligibility for wealthy homeowners

The survey drew a fantastic 2,000 responses with over 1,000 comments and polar opposite views on what is good policy. Do most people believe the home should be in the age pension asset test, and what do they say?

100 Aussies: five charts on who earns, pays and owns

Any policy decision needs to recognise who is affected by a change. It pays to check the data on who pays taxes, who owns assets and who earns the income to ensure an equitable and efficient outcome.

Three good comments from the pension asset test article

With articles on the pensions assets test read about 40,000 times, 3,500 survey responses and thousands of comments, there was a lot of great reader participation. A few comments added extra insights.

The sorry saga of housing affordability and ownership

It is hard to think of any area of widespread public concern where the same policies have been pursued for so long, in the face of such incontrovertible evidence that they have failed to achieve their objectives.

Latest Updates

Superannuation

The 'Contrast Principle' used by super fund test failures

Rather than compare results against APRA's benchmark, large super funds which failed the YFYS performance test are using another measure such as a CPI+ target, with more favourable results to show their members.

Property

RBA switched rate priority on house prices versus jobs

RBA Governor, Philip Lowe, says that surging house prices are not as important as full employment, but a previous Governor, Glenn Stevens, had other priorities, putting the "elevated level of house prices" first.

Investment strategies

Disruptive innovation and the Tesla valuation debate

Two prominent fund managers with strongly opposing views and techniques. Cathie Wood thinks Tesla is going to US$3,000, Rob Arnott says it's already a bubble at US$750. They debate valuing growth and disruption.

Shares

4 key materials for batteries and 9 companies that will benefit

Four key materials are required for battery production as we head towards 30X the number of electric cars. It opens exciting opportunities for Australian companies as the country aims to become a regional hub.

Shares

Why valuation multiples fail in an exponential world

Estimating the value of a company based on a multiple of earnings is a common investment analysis technique, but it is often useless. Multiples do a poor job of valuing the best growth businesses, like Microsoft.

Shares

Five value chains driving the ‘transition winners’

The ability to adapt to change makes a company more likely to sustain today’s profitability. There are five value chains plus a focus on cashflow and asset growth that the 'transition winners' are adopting.

Superannuation

Halving super drawdowns helps wealthy retirees most

At the start of COVID, the Government allowed early access to super, but in a strange twist, others were permitted to leave money in tax-advantaged super for another year. It helped the wealthy and should not be repeated.

Sponsors

Alliances

© 2021 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.