With market volatility looking increasingly persistent, we are often requested to position portfolios to minimise volatility. In doing so, we seek to ensure that there is a sufficient capital base from which to produce an acceptable income stream to maintain a comfortable retirement now and well into the future. In particular, we note that during the accumulation stage an investor needs to ensure that he or she achieves some capital growth so that the pension stage is adequately supported.

At Clime, we have constructed a higher income – low volatility (HILV) portfolio that has provided a risk adjusted high single digit positive return with low annualised volatility over the past 2 to 3 years. This compares favourably with the negative return of the share market over the same period and has done so with dramatically less volatility. Indeed the income portfolio’s volatility is approximately half that of the equity market. We believe that our HILV portfolio is a sensible approach for risk averse investors who already have a satisfactory investment capital base for retirement.

Our view is that the demand for higher income and lower volatility investment portfolios will become more important given the ageing population of Australia and those of other developed nations such as the USA, Europe and North Asia.

We address this need through extensive modelling across a spectrum of listed asset classes, each with different risk profiles.

Based on the latest ASFA Retirement Standard figures it is estimated that an income stream of $55,000 is required for an “average” couple to be reasonably comfortable in retirement. In contrast for a couple to live in a modest lifestyle, there is a need for about $32,000. We have reproduced the table below and refer to the AFSA website for further detailed analysis.

	Modest lifestyle – single	Modest lifestyle – couple	Comfortable lifestyle – single	Comfortable lifestyle – couple
Housing – ongoing[1]	$57.96	$55.64	$67.18	$77.88
Energy	$34.16	$45.37	$34.66	$47.01
Food	$75.74	$156.89	$108.20	$194.76
Clothing	$18.18	$29.52	$39.36	$59.04
Household goods and services	$26.06	$35.33	$73.30	$85.87
Health	$34.75	$67.07	$68.94	$121.68
Transport	$92.21	$94.82	$137.41	$140.02
Leisure	$72.82	$108.48	$220.66	$302.39
Communications	$9.21	$16.12	$25.30	$32.21
Total per week	$421.09	$609.24	$775.03	$1060.86
Total per year	$21,957	$31,767	$40,412	$55,316

Source: ASFA

Based on the latest ABS data release on the 14 October 2011[2], we note the following:

1. The average wealth of the Australian household (including financial and non-financial assets) was $720,000. However the key data we should look at is the median and this is substantially lower at $426,000. In other words, the household net wealth is concentrated at the top end of households.
2. The wealthiest 20% of households have on average $2.2m of wealth and account for roughly 66% of total household wealth[3]. Again this is further skewed to the Category of “super rich” as the median of this wealthy grouping is a lot lower at $1.47M.
3. Wealth is concentrated towards the retirement group with the average age of the top 20% wealthiest households being 57 years. In this group the mean gross income per week is $2,665 (or just over $138,000/year). Over 61% of this group own their home. This also neatly corresponds to the average household net wealth peaking in the 55 – 64 years age group where the net wealth peaks around $1.15M. Of this $782,000 are non-financial assets mainly a residence. Once non-financial assets are removed from this group then on average they have about $400.000 of investable assets.
4. Amongst the wealthy households, the net wealth dips post 65 years. This is not surprising as in this sub-group people have substantially moved into retirement (pension) mode. Income drops with age since capital is deployed for living expenses. This is clearly shown by the fact that the average net wealth of household peaks in the 55 – 64 years group and drops off to below $780,000 for those household of 75 years or older.

Based on the information provided above, it is possible to construct a HILV portfolio with the aim of achieving the minimum sum most need to retire comfortably. We believe it is important for individuals and couples to contemplate their targeted objective and set realistic goals which are capable of being achieved.

Our starting parameters are:

Starting	parameters Value	Comments
ASX200	4,200	November 2011
Inflation	3.0% pa	RBA’s upper target range
BBSW 90	4.60%	November 2011
Portfolio volatility	7.5% to 8.0% pa	See footnote[4]
Household income	$138,000	See ABS data or point 3 above
Initial sum	$400,000	See ABS data or point 3 above
Pay increment	3.0%	Assume similar to inflation
Time frame	8 to 10 years	Accumulation phase prior to retirement

In addition, to be conservative, we have built into our models the probability of a 33% negative return of the HILV portfolio in any one year (note recent example of 2008). We then calculate the percentage of household savings required per annum to achieve an income stream that will provide for a comfortable lifestyle in retirement based on these starting parameters. Furthermore, we require this strategy to be executed via a DIY superannuation fund noting particularly the net saving in taxes for higher gross mean income groups through salary sacrifice.

Based on the latest ABS data, we have defined the typical approaching-retirement couple as those with the following characteristics:

• A. a median age of 57 years old;
• B. with average financial assets of $400,000;
• C. household income of $138,000 p.a.; and
• D. who already own their own house with no mortgage as our starting point.

With a median age of 57 years old, this implies that there is a maximum time frame of about 8 to 10 years to retirement[5] for this sub-group.

Based on these input parameters it is possible to undertake some longer term modelling to derive the minimum amount of superannuation contributions required to go into the household’s accumulation account. The aim is for the present value of the income generated from the accumulated capital to be above $55,000 in 8 to 10 year’s time from the starting amount of $400,000. We assume that at retirement, the strategy of the HILV portfolio remains unchanged to provide for an income stream instead of cashing out.

Our modelling suggests that a typical couple who fit into the top 20% of wealthiest households would still need to increase their contributions into superannuation from the compulsory 9% to about 25% to achieve a comfortable retirement once the head of the household reaches 65 years old in 8 years time. Alternatively, they can work an additional 2 years to age 67 years and the addition contribution to the DIY super account would drop to 20% (i.e. 11% additional salary sacrifices) from 25%.

On the other hand, if the household started with an initial sum of $500,000 in investable assets instead of $400,000, the addition superannuation contribution they have to make drops to 15% from 25% to retire at age 65. In another scenario, if this typical household aims to stop working at 67 years old, then they only require 11% (or only 2% above the 9% compulsory superannuation) to achieve a comfortable retirement.

This relationship between the percentage of household income to be channelled into a DIY superannuation account and the initial starting amount of investable assets at year 57 years old with a household gross income per annum of $138,000 is graphically represented in the chart below.

Figure. 1 The percentage of household income to be channelled in to a DIY superannuation account as a function of the initial sum of financial assets in the DIY super account for a couple to retire comfortably at age 65 and 67 assuming that their median age is 57 years currently with an annual gross income per household of $138,000.

We emphasise that this modelling does not take into account one-off circumstances such as sickness in the family or loss of job, separation /divorce etc. It is imperative that people should build in a buffer for such an unforeseeable circumstance. In our view, this implies higher superannuation contributions above the minimum amount are advisable.

Given our view that the developed world is moving into a slower growth environment as a result of deleveraging, we believe that those approaching retirement should seriously reassess their risk and return profiles to re-evaluate their strategy for a comfortable retirement.

At Clime, our primary goal is capital preservation followed by income and capital growth. In this era of deleveraging and an ageing population, it is critical that the typical investor approaching retirement who is still in the accumulation phase, be ahead of the curve and plan for the draw-down phase of retirement.

In the new year, we will revisit this topic and provide some insights into the management of financial assets in retirement using the HILV approach.

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[1] These figures assume the retirees own their own houses and thus relate to the ongoing maintenance of their dwelling.

[2] Household Wealth and Wealth Distribution – Australia – 2009 -10.

[3] Note the household wealth here includes all non-financial assets such as the family home.

[4] This is an indication based on an extensive modelling on our model HILV portfolio over different times.

[5] We note that the official pension age in Australia has been moved from 65 to 67 years but it is likely that those who can afford would still like to retiree at 65 years old.