Research Question 3 111

Baby boomers face significant financial issues as they are likely to have financial responsibility for three generations - their parents, themselves and their children - over a longer life time, using smaller levels of accumulated mandatory superannuation savings (Shacklock and Brunetto, 2011, p. 743).

Teh (2014) describes the outcomes of sequencing risk as ‘catastrophic’, ‘tragic’ and ‘the difference between living comfortably in the golden years where grandchildren are spoilt versus the harsh reality of dying in poverty’ (p. 8).

Stolz et al. (2014, p. 20) demonstrated that adequacy of retirement income should be

linked to retirement product design rather than benchmarking the performance of an investment and further, that the proportion of growth assets in a portfolio has a major impact on retirement adequacy, despite sequencing risk issues. In the first part of this study, the investment strategies that are in place in industry superannuation funds were identified. Then, in the second part of the investigation, pre-retirement investment risk was linked to the potential accumulated value of retirement funds. In this section, the calculated accumulated funds will be used to assess how financial needs are met in retirement to answer RQ3 – How do these outcomes impact as part of the retirement life cycle? Relating these concepts to a retirement scenario, consideration needs to be given to a number of factors, including health, retirement age, potential for Centrelink aged pension, capital value at retirement, life expectancy, capital expenditure needs,

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drawdown levels, aged care considerations, family situation, estate matters, flexibility requirements and risk tolerance.

From a theoretical perspective, the study is moving from a quantitative perspective to a qualitative perspective, as the optimal portfolio construction elements of MPT identified in the first parts of the study (mean variance) move to incorporate additional underlying factors that are necessary in accommodating the changing demographic, the retiring baby boomers, the need for flexibility, to access capital and to derive adequate income – ‘regardless of economic cycles’ (Jensen, 2015).

Ralston (2015) explains that ‘presenting superannuation in a consumption frame’ aids decision-making and links with current government thinking (2015, p. 7). Her research study considers different retiree cohorts and options for income in retirement.

From a retirement perspective, the accumulating value of superannuation in a default fund is devoid of context; there is no understanding of availability of other savings, debt levels, capital requirements, health considerations, dependency issues and aged care needs. In order to assess how investment outcomes impact as part of the retirement life cycle (RQ3), an assessment framework for retirement is proposed. The idea for the framework comes from research into aged care, where different levels of needs and complexity are identified and different levels of services are matched – with level one, needs are simple and services are basic, level 2 is for more complicated situations, requiring greater care and level 3 indicates complexity and greater levels of assessment (Sansoni et al., 2012).

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For retirement, an initial assessment filter is proposed, which is based on the age of the default fund member and the level of superannuation savings. In a general sense, accumulator fund members would fit a level one service need – with the default fund matching their more basic requirements. Baby boomers would be identified as needing more assistance and access to information on sequencing risk and the implications for investing; level 2. Potential retirees would require a comprehensive assessment, level 3.

To cater for baby boomers, key retirement life cycle issues were identified (Shacklock & Brunetto, 2011):

1. Sequencing risk management; 2. Product performance;

3. Household wealth;

4. Intergenerational dependency arrangements; 5. Health;

6. Financial security - expected income stream (superannuation and age pension), access to capital;

7. Values and beliefs.

In examining sequencing risk for baby boomers in terms of how investment outcomes impact, the following methodological approach is used:

Stage 1: Identify key factors, and variables, to develop a portfolio model of sequencing risk and simulate the impact of volatility for default and lifecycle benchmarks.

Stage 2: Model baby boomer retirement incomes, taking into account product options of an account based pension (ABP) and lifetime annuities (LA).

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In using this process, data collected and analysed in earlier stages of the study are incorporated in this section, so that greater levels of rigour can be used and to provide a deeper understanding of the problem.

Stage 1: In establishing key factors, the following assumptions are made: i. Retirement cohort is based on a single baby boomer aged 65. ii. Life expectancy is determined as 19.22 years3.

iii. Retirement income level is based on an average of lifestyle needs, given by the Association of Superannuation Funds of Australia (ASFA) Retirement Standard (March 2015). ASFA have determined that the annual budget needed for a single person to fund a modest retirement is $23,438 and $42,569 for increased comfort. A modest lifestyle would reflect a budget covering basic living costs, while a comfortable lifestyle would cater for those who would spend more overall, with occasional overseas holidays and the means to have a high standard of living. Taking the average of a modest and comfortable lifestyle for a single person, the average lifestyle (drawdown level) is calculated as $33,0004.

iv. Retirement income is to include the Centrelink age pension for a homeowner, with entitlement shown as $22,000 per annum, based on rates as at 1 July 20155:

 Age pension of $782.20 per fortnight, subject to means tests;

 Clean energy supplement $14.10 per fortnight;

 Pension supplement $63.90 per fortnight;

 Pharmaceutical allowance $6.20 per fortnight.

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Based on Australian Government 2010-12 Life Expectancy Tables: 65 year old male. 4

($ 23,438 + $42,569)/2, rounded to $33,000. 5

Centrelink Age Pension: $782.20 + $14.10 + $63.90 + $6.20 = $866.40 per fortnight, or $22,526.40 per annum, rounded to $22,000.

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v. Superannuation income stream sourced from a lump sum invested in either default or lifecycle benchmarks, with a portfolio value of $152,0006.

vi. No other assets, income or debt is held.

To simulate the impact of volatility relative to capital available at retirement; a Monte Carlo simulation model is used. The genesis of the model came from research that referred to a PensionMetrics model of Blake et al. (2001). Instead of using one constant rate of return, a group of random scenarios are used to assess the many different possible outcomes in retirement. Given the relatively high reported standard deviations, random returns are more realistic in an investment scenario, than a fixed or constant rate of return. As default funds are linked to strategic asset allocations, so too are they linked to investment return objectives. The model incorporates the need for monthly drawdowns and is driven by key data:

1. Retirement Portfolio Value $152,000; 2. Monthly Drawdown $9177;

3. Anticipated Average Return: based on data analysis for RQ2; 4. Anticipated Standard Deviation: based on data analysis for RQ2.

Data analysed in understanding investment and default and lifecycle benchmark issues, provides risk and return variables to create output for simulation analysis and considers:

1. Maximum wealth; 2. Minimum wealth;

The model uses 250 trials over 240 months and has been run for the default and

lifecycle benchmark funds for periods ending 2009 and 2013. Results are compiled

6

Desired cash flow: $33,000 per annum less full age pension $22,000 per annum = $11,000 per annum;

Portfolio value = $11,000 x 1-(1+0.035) -19.22/0.035, rounded to $152,000 7

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and evaluated to assess investment outcome implications.

Stage 2: In modelling baby boomer retirement incomes, data comprises of: i. Retirement cohort based on a single baby boomer aged 65.

ii. Retirement income of $33,000 net per annum (including age pension) sourced from superannuation income stream portfolio of $152,000 invested in:

 100% account-based pension (ABP), or

 75% account based pension, 25% lifetime annuity (LA).

iii. Lifetime annuity is based on a payout of $0.4618 per $1,000 over lifetime. iv. No other assets, income or debt is held.

The data collection and analysis approach used in this study provides a mix of assessment components, with sequencing risk studied in a (tentatively proposed) holistic context. While the implications of retirement for a baby boomer can cover a diverse range of issues, the elements of examining sequencing risk in this study have been used to explore options, to aid decision-making.