Feeling the pension pinch
PORTFOLIO POINT: Many Australian pensioners are being forced to sell their shares at rock bottom prices to maintain their cash flow … and that needs to change.
When we talk about the ‘structural issues’ in the financial services industry, we tend to think about things such as commissions influencing the judgements of those advising on investments, the conflict of interest that sees institutions providing both investment products and advice, and the low educational thresholds for financial planners.
But another structural problem that has received far too little attention is when retail pension products force retirees to sell their shares when prices are low. This caused significant destruction of wealth during the global financial crisis and has the potential to do the same if sharemarkets fall again.
Let’s consider an example of how this happens in practice. Consider an investor in a Q-Super balanced pension fund – a good, low-cost fund with comparatively good investment performance (compared to managed fund style peers of 2.35% a year over the past five years while the Australian sharemarket has fallen in value by about 35% over the same period). Let’s assume an investor put $1 million into this fund at retirement in October 2007, and wanted to draw a pension of $48,000 a year, or $4,000 a month.
In mid October of 2007, the unit price of the fund was $2.25. At this time investing $1 million into the fund would buy 444,444 units.
Assuming they take their first $4,000 pension payment in October 2007, 1,778 of their units would be sold ($4,000/$2.25 unit price) to make the $4,000 pension payment.
Fast forward 18 months into retirement, and the sharemarket low of early 2009. The Q Super balanced pension fund had a unit price at this time of $1.65. To make the $4,000 pension payment the fund had to sell 2,424 units – or an extra 646 units.
This situation represents a double problem for investors here. Firstly the unit price of the fund has fallen because of the fall in sharemarket values, so they are effectively selling shares at low prices. Secondly, because people tend to take regular pension amounts, they are now having to sell more units at these low prices – not a good combination of factors for investors.
The basis of this problem is this. Many people in industry, government and retail pension products use ‘unitised’ pension products to fund their retirement. They will own units in a managed fund style pension funds – often a ‘balanced’ fund. On a regular basis – often monthly – they sell units to pay their pension. These units, and their unit prices, will represent a mix of assets that will commonly include Australian and international shares, listed property investments, fixed interest and cash investments. So, when investment markets fall sharply in value, as they did during the GFC, the unit price also drops sharply. When the next pension payment is taken, more units have to be sold to generate the amount of the pension payment.
Ken Henry talked recently about the over-exposure that many superannuation funds have to shares. It stands to reason that his comments would be even more significant for people in retirement, who will be impacted more by a fall in sharemarket values. This analysis, however, goes beyond just the problem of volatility in equities. It demonstrates the way that a fall in sharemarket values has a potential threefold negative impact on the financial position of a retiree who relies on owning units in a pension fund:
- The value of their overall pension investment falls, because the unit price of their holding has fallen.
- When they take pension payments by selling units, they are selling those units at lower prices – effectively selling shares at low prices.
- They have to sell units at lower prices – meaning they have to sell more units to make their pension payment. (Admittedly there is likely to be the option to take lower pension payments, but if a pension investor did this they face a negative impact on their lifestyle).
This is a significant problem in the provision of pension income streams. The amount of exposure that many funds have to shares is a structural problem that sees a long-term investment (shares) used to fund short-term cash needs (the selling of units to make regular pension payments).
If Ken Henry is correct, not only might many pension investors have too much exposure to shares but their shares are being used incorrectly as a short-term investment.
The Solution
There is a simple and profound quote around investment strategy. “Cash lets you sleep, shares let you eat”.
Translated, it means that cash is a great short-term investment that provides liquidity and certainty. Shares (and I would say growth assets generally, including property) are important to provide long-term income to counter the significant effects of inflation over time.
And the solution to this problem: use cash for your short-term needs, including pension payments, and let the growth assets provide returns over time.
Pension funds with cash accounts – including self-managed super funds, wrap accounts and many pension funds – that allow investors to choose individual asset class investments and have the pension withdrawn from just one option (the cash option) are the solution.
The pension investor can ensure that they have enough assets in their cash accounts to cover whatever period of time makes them comfortable. Using the case study above, the person drawing $48,000 a year with $1 million of assets might want six years’ of pension payments, or around $300,000, in this cash account. The rest can be invested in a mix of fixed interest, property, shares and other assets that they deem appropriate – all of which will hopefully be paying interest, dividends, distributions and income to top the cash account up.
This solution means that a pension investor with a cash account will not be forced to sell growth assets to make pension payments.
Conclusion
For investors in unitised pension investments, the forced sale of growth assets to make pension payments magnifies significant market downturns. Taking enough control of a pension account to include and manage a cash account means that pensions can be taken from short-term cash holdings – avoiding the forced sale of growth assets during a market downturn.
Scott Francis is a personal finance commentator, and previously worked as an independent financial advisor. He has investments in Q Super accumulation accounts.
Frequently Asked Questions about this Article…
A unitised pension fund is a managed fund where your pension is paid by selling units from your holding (often monthly). When markets fall the fund’s unit price drops, so the fund must sell more units to meet a fixed pension payment — effectively forcing retirees to sell growth assets like shares at depressed prices.
The article uses a Q‑Super balanced pension example: $1 million invested in October 2007 bought 444,444 units at $2.25. A $4,000 monthly pension then required selling 1,778 units. By early 2009 the unit price had fallen to $1.65, so the same $4,000 required selling 2,424 units — 646 more units sold at a much lower price, magnifying losses for the retiree.
The article highlights three linked harms: (1) the overall value of the pension falls because unit prices drop; (2) pension payments require selling units at those lower prices, locking in losses; and (3) retirees must sell more units to raise the same cash, further depleting their growth assets.
The recommended solution is to hold a cash account inside your pension (available in SMSFs, wrap accounts and many retail pension funds) and take pension payments from that cash option. This preserves growth assets (shares, property) to recover and provide long‑term returns while cash covers short‑term income needs.
There’s no one‑size‑fits‑all answer, but the article gives a practical example: someone drawing $48,000 a year on $1 million might keep about six years’ payments (roughly $300,000) in cash. Choose a period you’re comfortable with so you don’t have to sell growth assets during market stress.
It means cash provides liquidity and certainty for short‑term living expenses (so you can sleep peacefully), while shares and other growth assets are intended to generate long‑term returns that protect against inflation and provide future income (they ‘let you eat’ over the long run).
Yes — the article echoes concerns (referencing Ken Henry) that too much share exposure can be especially harmful in retirement because market falls force the sale of growth assets to fund regular payments. Managing asset allocation and holding a cash buffer helps reduce that risk.
Yes. The article notes that Scott Francis is a personal finance commentator and previously worked as an independent financial adviser, and that he has investments in Q Super accumulation accounts.
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