One of the major messages that superfunds direct to young people is not as straight forward as it seems – and may even hurt them financially.
You see, superannuation funds often encourage young people to put extra money into superannuation, so that they can reap the long term benefits of compounding. The logic is simple – put more money in now and there will be more there to grow and compound over the long term – possibly lots more.
The result of the funds’ projections is pure mathematics – and maths does not lie.
I have over 30 years experience in financial planning and I can tell you that things are never that simple.
For one thing, the maths is based on assumptions about the future. If you change the assumptions, you change the outcome – possibly by a lot. Let us look at a couple of the assumptions:
• Future earning rates are assumed to be close to historical earning rates. While this assumption may well be true over the very long term of several decades, earnings by sharemarkets, real estate and bonds, can differ significantly from historical returns, for extended periods. Just look at interest rates over the last 10 years, compared with rates over the previous 20 years.
• It is assumed that the current tax benefits of superannuation will stay more or less the same forever – but this may well not be the case. Governments face ever increasing demands to provide more and more services, and the superannuation pool of over $2trillion will be a more and more tempting target. An increase in the superannuation tax of a few per cent will yield a big bounty for the Government, whatever party is in power. Two years age the Liberal Government restricted the amount that retirees could move into allocated pensions – thus effectively increasing the tax paid by superannuation funds. Now there are reports in the London Telegraph (8th February 2020) that the UK Conservative Government is considering reducing the tax breaks for private pension funds.
• Then there is sequencing risk. What matters is not just the average return over your period in a fund, but exactly when you receive the various higher and lower returns – but that is for another time.
Then there are the human factors.
Life is not just about superannuation, but lots of things like buying a house, having a family, paying the multitude of expenses around raising children, holidays, ongoing career changes and education, family splits, etc. etc. etc.
Life is complicated, in ways that quick compound calculations don’t accommodate.
Anyway, if extra superannuation is not all its cracked up to be, what are the alternatives? Here are a few:
- Use extra cash to pay off the mortgage as soon as possible.
People are borrowing big sums to get into a house and one aim should be to pay the mortgage off as quickly as possible.
Record low interest rates make the fast repayment option especially attractive – and, get that mortgage down before interest rates go up. At some points, rates will go up. It may not be soon, but it will happen, and if you are left with a big mortgage when rates rise, the result could be considerable financial pain.
- Build a (non-superannuation) cash reserve to tide you over tough times. There is no knowing when setbacks will happen (such as loss of a job, a serious accident, illness, or relationship breakdown). In these sort of situations, a healthy cash reserve means you don’t have to add financial worries to your other worries – and that’s a big plus.
- Be prepared for rising insurance costs as you get older.
I could go on, but I think you get the picture.
Life can be complicated, and when planning you need to look far more broadly than just looking at one aspect.
A large superannuation balance should position you to thrive in retirement.
The catch is, before you can thrive you must first survive – the multitude of obstacles and setbacks that life can throw up.
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