Here's a question for you Australians. Roughly what percentage of your assets, which you intend to produce income for when you are retired, are in “risky” growth assets such as shares and property?
OK, if you know, well done, that’s a great start. You’re doing much better than most people!
Now here’s another question for you. What percentage of your assets should be invested in “risky” growth assets? I know a lot of actuaries who, like me, think this is a hard question – and we are supposed to be familiar with asset classes and investment risks and returns!
Of course, you can always turn to a financial adviser for advice. In Australia at least if you go to an adviser, you'll be asked to complete a “risk profile questionnaire”, the point of which is to find out how much “risk” you are prepared to take in search of higher returns. Many (though not all) financial advisers will base their recommended asset allocation on the outcome of the risk profile questionnaire. But the “attitude to risk” that is revealed by risk profile questionnaires is your attitude to the risk that assets will move up and down in value over a short time period, not the risk that the invested assets will be unable to produce the worker’s target retirement income. It is the second type of “risk” that you should really be interested in.
I recently wrote a paper for the Sydney 2015 Actuaries Summit, A stochastic approach to retirement income planning, in which I asked the question: what percentage of assets should be invested in growth assets to produce the greatest number of years in retirement during which the assets (together with the age pension) continue to produce the target retirement income? The answers are shown in the table in the graphic above.
If you have enough assets so that together with your age pension entitlement you will achieve your target retirement income with little risk by investing in "low risk" assets, then you should do that rather than take more investment risk. But if your assets are not comfortably sufficient to provide for your retirement, you need to take more risk in your asset selection to aim for the higher rate of return that you need.
Of course, the above table is not to be taken as personal financial advice, because the table shows results in a simplified format and none of your personal circumstances have been taken into account. But what does emerge is that all of the following input variables are relevant – age, salary, superannuation balance and target retirement income. But these factors are barely considered in the risk profile questionnaire. So risk profile questionnaires alone are not sufficient to produce “optimal” decisions about how to invest.
But the cavalry is coming! In the next five years, both existing firms and start-ups will build “robo-advice” (automated financial advice) tools that allow the user to input their personal financial and demographic data, use probability based approaches to project asset returns, and allow for individual preferences in deciding between alternative uncertain future consumption patterns. It seems likely that in the future, advice will be delivered via technology and will allow more appropriately for individual preferences in relation to the “risks” that are really important.
If you have ever completed a "risk profile questionnaire", what did you think of it? What did you think of the asset allocation that was recommended for you? Might you ever consider “robo-advice"?
Category: Funding longer lives: Pension/retirement