Super Done Right 💰

Like any investment in the stock market, index funds can go up or down. On the risk-return curve, shares are near the top of the risk-return curve (‘alternative investments’ are things like cryptocurrency and speculative stocks).

In general, though, investing in an index fund option is ‘safer’ than individual stocks. Short of the apocalypse, you’re never going to lose all of your money investing in an index. But a stock can certainly go to zero – companies go bust all the time. On average, you will have negative returns six out of every 20 years. As you approach retirement, perhaps 10 years out, so you reduce the impact of stock market fluctuations on your super value (and avoid the worst-case scenario of having to delay retirement because of a stock market crash!), you should gradually make bonds or other safe assets a greater percentage of your portfolio. Most super funds will have a ‘transition to retirement’ program which does this automatically.

You should know that by putting your super in index funds, it will be more volatile – bigger ups and downs – than having it in a MySuper option. But this also limits growth. Over the long-term, index funds will come out ahead. You should try to get a sense of your own risk tolerance: when the market is down, the worst thing you can do is take money out of the market, which ‘realises’ your losses.

It can be tempting to check your day-to-day super balance. If that’s motivating for you, that’s fine – but be careful about letting it influence your emotions too much. If you don’t think you could stomach your super losing 20% on paper for a couple of years, consider allocating 20% of your super to a bond index fund to reduce volatility. You can also go back to higher-fee MySuper options, which are usually made up of international stocks plus a whole range of other assets such as property, domestic stocks, bonds and cash. MySuper will usually deliver lower returns with a lower volatility.

Research has shown 14 that investing regularly will leave you with more money than trying to move money around. Time in the market beats timing the market.

The first rule of compounding: Never interrupt it unnecessarily.

Charlie Munger, investing partner of Warren Buffet

Retail super funds are run for shareholders (not members), and industry funds are for members.

If you are in a retail fund, get out. On average, their fees are double that of industry funds. 15 They justify these fees with promises of higher returns and beating the market. Unfortunately for them and their members, active management has been proven, time and time again, to underperform the market in the long run. 16 On average, retail fund returns are 2% lower than industry funds, and of member accounts underperforming the benchmark of 2005-17 returns, 77% were in retail funds. Over a long time, this underperformance could make you over half a million dollars poorer in retirement than someone in a not-for-profit industry fund. 17 If you’re in a retail fund, you’re probably giving the people running it too much of your retirement.

I am not qualified to tell you if you need insurance through your super account, but many people find it a convenient way to get coverage for things like income protection, total and permanent disability (TPD) and life insurance. Twelve million Australians have some form of insurance through their super. 18 Some people argue that having lots of people signed up through super for insurance helps to keep premiums down for everyone, and that automatic enrolment has helped address an underinsurance gap in Australia.

But not everyone gets good value from this insurance. The insurance premiums come out of your super, reducing the balance. This has a particularly large effect on low-income fund members, or those with intermittent work, who both have their total super balance reduced by premiums while not working and often face stricter criteria to claim on that insurance (there are usually clauses that make it harder to claim if you haven’t worked for 3, 6 or 9+ months). The Productivity Commission estimates this could reduce a low-income fund member’s total super balance by $85,000, or $125,000 if they also have duplicate insurance policies.

Speaking of – 17% of MySuper fund members had duplicate insurance policies across multiple accounts, leading to a retirement balance up to $50,000 lower. Some members are defaulted into insurance they cannot claim, with income protection insurance the worst offender. This is because members can usually only claim one income protection policy and, even then, only when they’re working. From the report: “A typical full-time worker can expect insurance to erode their retirement balance by $60,000 if they have income protection cover, compared with $35,000 if they only have life and disability cover.”

Nine million Australians hold TPD (disability) insurance, 86% through super. But ASIC, the financial regulator, found that the much stricter disability tests applied by some super funds would lead to 60% of TPD claims being rejected – instead of 12% under a standard test. These most often affect people who are working part-time or casual hours, are out of the workforce, are working in ‘hazardous occupations’ or are full-time carers. So make sure you read the insurance documents and work out what fits your needs.

If you have no dependents, life insurance is probably unnecessary, but some people like to keep some low level ($20,000-$50,000) for peace of mind to avoid funeral bills.

Keep in mind that as long as you’re over 25 and with a balance of over $6,000, you automatically get insurance through your super. This means you don’t have to have any medical tests; you can walk straight in. This is generally much easier than getting insurance outside of your super.

When closing any super account, you should make sure that you don’t need any of the insurance that might come with it – people sometimes keep a separate super account just to access particularly relevant insurance. This might be a rare case, but you should speak to a financial or insurance adviser. This becomes more important as you near retirement and some insurers stop accepting older members.

There is a long-running debate about whether ethical investing, also called ESG investing (environmental, social, governance) or sustainable investing, has real benefits or is just a marketing trick to attract well-meaning, environmentally-conscious consumers.

I will go into more detail below, but the short answer is that if ethical funds are the reason you invest, invest in ethical funds. You will probably have lower returns in the long run, but it’s much better than not investing at all. If you either don’t care or think that ESG is just a marketing trick, invest in the regular market. You can donate to a cause you think is deserving, which will potentially have more tangible benefits than changing your investment style.

People arguing in favour of ESG investing say that it’s a powerful signal to companies and the market that consumers care about the environment. There have been massive inflows to the sustainable fund industry, which stands at around USD$35 trillion in 2022 and Bloomberg Intelligence reckons could exceed USD$50 trillion by 2025.

Those against it say it distorts the market, undervaluing polluting companies. Those undervalued companies then become a nice little profit-maker for other funds – and there are always other funds. 19 For more detail, NYU finance professor Aswath Damodaran has a good ESG-skeptic take on his blog. A recent WSJ column concludes that “if ESG investing truly offers rewards to investors, it brings no virtue. If it is virtuous, expect a lower reward.”

I am a cynic, particularly when it comes to advertising. Ethical investing advertising disproportionately targets young people. This is probably because young people care more about the environment and social issues. But young people are also the highest-value clients. Like the banking and insurance industries, the super industry knows that the lifetime value, the total value of a customer, is highest when they’re young. This is because while super funds earn the majority of fees right before customers retire, super is an extremely ‘sticky’ product. That means people are very unlikely to change super funds – mostly because it’s perceived as a hassle.

If you’re anything like me, your reaction to that little disclaimer is just to brush it off – they’ve got to put it there, right? Check out those returns! Yes, but it’s a bit more complicated than that.

Counterintuitively, the best place to put your money is actually in assets that have recently underperformed. Jumping around, chasing the highest return number year-to-year is like trying to surf on a wave that’s already finished breaking. You’re just left with foam and sand.

This chart illustrates this principle well. You might see the US’ returns over the last few years and think ‘wow, I should jump on that train’. But, really, looking at the chart it’s clear the pendulum is overdue for a swing back in the other direction.

As Australian investors, this doesn’t really matter for us – international index funds capture both US and international (that is, equity markets outside the US) markets. The other nice thing is that, when investing for the long term – for something like retirement – even these swings in performance become negligible. Even if you make a ‘mistake’ and invest in US stocks right as they start underperforming, all it will do is let you accumulate more US stocks while they’re ‘cheaper’ – that is, undervalued. As long as you keep your money in the market, you can’t really go wrong in the long run. 20

You can get more good info on diversification and US vs non-US performance from Vanguard Research. Spoiler: “we expect that investors who maintain globally diversified equity portfolios will be rewarded in the years ahead.”

Inflation is rising sharply around the developed world. Although some economists expect it to improve by 2023, many consumers are already feeling the pinch of higher prices. The best way to protect the value of your money during periods of inflation is to avoid cash and keep your assets in equities (stocks, index funds etc), commodities or real estate. But don’t overreact; putting your entire retirement into gold is likely to be a mistake (remember: pulling funds out of the market when things get shaky is a near-guaranteed way to lose money in the long run).

There’s a growing trend of super funds merging. This is a good thing for consumers, as it means super funds are facing competition to cut costs and provide more competitive returns. In general, a larger fund with more assets under management will be able to offer the same services for lower fees. Many smaller super funds are only able to keep existing because super is a very ‘sticky’ product – consumers rarely change super funds. Consider, for example, how only one third of Australians have ever switched fund options, let alone entire funds! For consumers, it’s generally safest to go with a large industry super fund, but always check the fees and the PDS. Vanguard, an American company that invented the index fund as we know it today, is set to enter the super market in 2022. They’re sure to have competitive rates, so keep an eye out.

In 2021-22 you can contribute a maximum of $27,500 ($25,000 in the past few years) to your super at the 15% tax rate. Contributions beyond that are taxed at your income tax rate. However, as long as your super balance is under $500,000, if you didn’t use your entire cap at any point in the last five years (starting in 2018-19), you can ‘top up’ that unused cap at the 15% tax rate. If you do that with after-tax income, you can claim it at tax time for a rebate. This is particularly useful if you have some spare cash, as you save a significant amount (your marginal tax rate minus 15%) by investing it in super over any other option. The ATO tracks the amount you can catch up; you can see it at myGov. Most super funds will have information on how to make additional or catch-up contributions.

This question becomes most relevant when people are deciding how to invest a larger portion of money – whether it’s best off in the market after-tax, paying off a mortgage, saving up for a house deposit or ‘locked away’ in super. 21

The main incentive to invest in super is the lower tax you pay: just 15% (up to the current concessional contribution limit of $27,500 per year). If you want to save money for retirement, super is absolutely the best place to do that. Putting your money in super also has several other advantages. Similar to getting a mortgage in the ‘rent or buy’ debate, super is a form of forced savings. You won’t be able to take it out to spend on things before you retire (you can access it early in some circumstances, but the ATO has very strict criteria).

As for you earning way more investing outside of super, not only do you pay up to 30% additional tax if you take that route, but most professional fund managers can’t even beat the market average over a 20-year timeframe, so what makes you think you can? And that’s not even counting the hours spent researching stocks and the additional stress of market volatility. You can invest in stocks through your super if you set up a self-managed super fund, though that’s generally only worth doing once your super balance gets past about $400,000. At that point, go find an accountant who specialises in SMSFs. Some super funds also allow a ‘self-managed’ option, where you pick from a list of approved – usually safer – stocks.

And for not wanting to have money ‘locked away’ until retirement: in an ideal world, you should have investments outside of super. This gives you more flexibility, especially if you’re wanting to retire early.22 But any investment in index funds most reliably provides good returns if it’s left in the market for a long time – 10-plus years, preferably longer – so trying to make a quick buck is as likely to fail as to succeed.

Also, people are generally bad at thinking long-term. Do you really believe you won’t reach retirement age? Just because it seems far away, it doesn’t mean it won’t one day arrive. What would ‘future you’ want you to do?

Picking individual stocks, particularly small ones, is a very good way to lose money. If you need to scratch that itch, perhaps set up a small amount – no more than 5% of your total investment – for excitement or wild bets. Mostly, investing should be boring and long-term.

This is a niche – but interesting – question. Let’s say a super fund wants to let its members invest in a low-cost international index fund. They can either manage it themselves, or, more likely, the super fund will buy a product like the MSCI World index and offer that to their members.

Why does this matter? In the scheme of things, it doesn’t – but it can lead to very minor differences between the indexed ‘products’ offered by different super funds. Of course, the biggest determinant will still be super fees – but small differences between these base products (e.g. whether the base index tracks 1,550 companies or 1,600 companies) can lead to gaps of a few fractions of a percent between different funds’ indexed options, even though they’re all offering ‘International Indexed’. For me, this is not worth worrying about.