How to achieve 20 % return p.a. in your super

In my previous blogs, I discussed longevity, retirement income levels (basic, moderate, comfortable and aspirational), average super fund balances at different age groups and average achievable returns.

Average, “easy” returns of a diversified fund over the last 25 years are 7.4%; average long term buy and hold returns on domestic and international shares are somewhere between 8% and 10% p.a.

In order to achieve this average share return, the investor will face a drawdown (losing period) in a bear market (when all shares are falling in price) of somewhere between 30% and 50%+ at some point.

Also, a buy and hold approach has to cope with an occasional 10 year period with zero or close to zero return.

If these situations occur just as you entre retirement, you can easily get into financial trouble.

Also, buy and hold requires you to do nothing….surprisingly, this is easier said than done!

Human nature makes us value the pain of a dollar lost almost double as the joy of a dollar earned!

This means that as human beings we often tend to buy stocks after they already went up significantly (called FOMO – Fear of Missing Out); OR

We tend not to realise small manageable losses and we tend to sell our entire portfolio in disgust close to the bottom of the bear market.

So that makes this 8% to 10% buy and hold return rather theoretical.

As you can probably see, I’m not a fan of the buy and hold approach…I would rather stick my neck out (which arguably gives more control).

My investment objective in a super fund (without leverage) is 20% p.a. And a 15% return would be acceptable – still beating the benchmark significantly.

So how do we achieve our target return of 20%?

Well, you need a strategy; it’s not going to happen by itself!

As human beings, we tend to let our losses run (hoping the market is going to bounce back to breakeven) and cut our profits short (fearing that the market will take our unrealised profits away).

In other words, we tend to do the opposite of good trading! And most uneducated investors lose money if they trade leveraged markets or greatly underperform the benchmark in unleveraged share investments.

We need an investment / trading system that answers the following questions:

• Which stocks do I buy and why?
• When do I buy the chosen stock?
• At what level do I sell a non-performing investment with a small, manageable loss?
• How and when do I take profits?
• How and when do I re-enter a previous position?
• How and when do I add to winning positions?
• How do I diversify?
• How do I stay disciplined and follow my rules?

Once you have a system, it’s basically like ticking boxes (just like the checklist of a pilot before takeoff) and your investment procedures can become quite mechanical.

Whatever the market throws at you, you know how to react, calmly and in a considered way.

So let’s answer the questions above, quickly, with a broad paint brush.

If I want to shoot for a 20% return, I will have to stick to growth stocks. Buying Telstra for the dividend only with no earnings growth in sight is NOT going to achieve my investment objective.

I will often have to find medium sized companies in new industries that can manage growth earnings by at least 20% p.a.

But picking the right company is only part of the story; you should also try to get the timing right…because as in finance, time is money.

I suggest not buying stocks in a downtrend (trying to catch a falling knife…), but wait until the stock is in a confirmed uptrend.

Using longer term moving averages is quite useful. The best time to buy a growth stock is when it finds support on a rising long term moving average and bounces off support or when it breaks out of a prior trading range on above average volume.

Then, and ONLY then can we buy a certain stock.

Before we buy we acknowledge that our investment thesis or our timing may be wrong and the stock could go down in value.

As such, we set a mental stop loss and sell – in a disciplined, not ‘questions asked’ way – if this stop loss level is reached. I would sell a stock if it drops below 4% to 10% of the purchase price and you can try another investment with the remaining funds.

If you are not losing money you must be making money and now comes the hardest part in investing: How to take profits.

You could take smaller profits more often, for example sell once you have reached a predetermined profit target such as 20%.

If you do this you will sometimes regret getting out of a good investment too early.

You could alternatively let the profits run until the medium to longer term trend reverses, for example if a trailing stop is triggered or the stock trades below a flattening long term moving average.

This strategy will keep you in trades often much longer for greater profits, but you tie up your capital for longer periods and by definition always get out too late.

Only liars get out at the exact top.

Combining small losses with larger profits will give you positive statistical expectancy, something like winning $2 on a coin flip when heads come up and losing $1 if tails come up.

You just have to repeat often enough and you are guaranteed to make money over the medium term with a cluster of losing trades pretty much guaranteed occasionally.

Once you are out of a profitable or losing trade you can re-enter if the stock still meets your previous selection criteria (earnings growth) and you find a technical sweet spot to enter as previously discussed.

As a winning trader, you do not average down (throw good money after bad), but you average up (pyramid), buy more shares if your previous position is profitable and another entry signal is triggered.

You don’t want to make the pyramid top heavy but buy incrementally less shares with every addition.

Most investors only invest in the big companies they know (CBA, Telstra and Woolworth are the usual suspects for Australian mum and dad investors) and they tend to have a home bias of only investing in domestic shares.

Given that Australia is only 2% of world market capitalisation, it does not make sense ignoring the remaining 98%.

I tend to invest in US stocks (about 50% of world market cap) as they have sectors we simply don’t have in Australia (FANGs, software, chip makers, biotech etc).

In order to follow the rules, first you have to have clear cut rules and they should be written down making it easier to follow.

Just stick to your rules and the profits will eventually come.

Don’t forget to do an occasional periodic review and ask yourself during the review if you have followed your rules.

If you have done so, pat yourself on the back even if it is a losing trade; if you haven’t done so, promise not to sin again in future.

But by all means continue researching and refining your trading plan. You’re never finished and that’s part of the fun! Trading and investing is never boring!

Go for it and enjoy the journey.

Once you apply such a strategy, you have set the odds in your favour to make 20% or even more.

Just apply the super fund accumulation rules discussed in previous blogs, add to your super and then trade it actively and you are set for a comfortable retirement. You just need a bit of patience.

When’s the best time to plan for retirement?

Easy answer: Now!

Let me explain: Young adults at the beginning of their career usually believe that they will live forever, never get old, never retire (ok, I exaggerate somewhat to make a point).

Therefore there is no need to dwell too long on the far away future and start thinking of retirement and retirement planning.

Not only that, but they have far more immediate needs such as buying a car, moving in with the girlfriend / boyfriend, getting the first furniture or buying their first property.

Retirement seems so far away and so unreal that they simply don’t care!

The government, in its wisdom, knows this and therefore forces all of us to save for our retirement into a superannuation fund via the super guarantee. As long as you earn above the minimum and are employed, there is pretty much no way around it.

But as retirement planning is not on the list of top priorities, most employees just put the minimum amount stipulated by law into a default super fund, nicely balanced in a bit of everything.

This reduces the downside…but ALSO reduces the upside!

And then they pretty much ignore it!

Strategies such as salary sacrificing are usually not considered until mid career or late accumulation phase (this is what I call the years immediately before retirement), until suddenly we realise:

“Houston, we have a problem…”

Yes, I get it…if you start out with a few thousand dollars in super (and often pay quite significant amounts for insurance that you don’t necessarily need at every stage in your life), seeing your super fund grow is like watching paint dry.

Too slow and too boring!

But that’s the challenge of compounding – at the start it takes quite some time until you reach critical mass and start seeing larger returns.

During the first few years in your super fund not much happens and you think you’re going nowhere. But over time, usually after around 10 years, the magic of compounding kicks in.

On the one hand you start increasing your super fund balance through regular, forced contributions from a hopefully increasing salary (and maybe some tax advantaged salary sacrifice).

On the other hand, the super balance accumulated so far will start increasing even faster through compounding.

This should generate moderate returns if you employ a buy and hold strategy favoured by most super fund managers.

Now I must say, it is easy for them, they just buy shares in the larger companies and hold them forever…and over the long term in a pure equity fund, they make somewhere between 8% and 10% p.a. before fees.

This return usually beats inflation and you will end up with an average super fund balance that won’t be quite enough for a comfortable retirement, but you won’t starve either.

But don’t we all want to be comfortable in retirement?

You could, alternatively, stick your neck out, take control of your super and actively manage your super.

At the beginning, your super fund balance will be too low to justify a self managed super fund, but even then you could actively trade individual shares through your industry or retail super fund. Most super funds let you do just that from a large list of domestic and international companies.

As you reach cruising speed and somewhere between $100,000 to $200,000, a Self Managed Super Fund (SMSF) starts making more sense…and total administrative fees start being lower than the fees charged by industry or retail funds.

What could our theoretical couple above do to improve their retirement condition?

The C250 turbo diesel Mercedes Benz sells for around $100,000…and with $20,000 in yearly depreciation, this is definitely a tempting alternative (hey, we worked hard all our life and need to reward ourselves…).

But.

There may be other, even more rewarding (long term) ways to allocate the funds freed up by no payments for the children and the mortgage.

How do you take advantage of a Self Managed Super Fund?

In order to ‘actively’ manage a super fund you obviously need to know what you are doing.

Trading and investing is simple: there are clear cut rules to success…  

…but not easy, due to psychological programming to do the opposite of what trading well is all about.

Psychologically, you are primed to let your losses run and cut your profits short!

So if you want to increase your returns over and above a relatively easy buy and hold return, you will have to learn the ‘rules of the game’.

This requires time and dedication, but at the end of the day the rewards can be enormous!

You can educate yourself through reading books and researching investment strategies…

…OR you could shortcut your education in employing a trading mentor in the same way you employ a personal trainer in a gym.

Your learning will accelerate and if you have chosen your mentor wisely (and put in the necessary work – there is no free lunch don’t forget) you could significantly beat market returns.

How much of a difference can I actually make for my retirement?

Compounding higher returns over the medium term really makes a difference!

Let me give you an example: The median mid career (age group 40 – 45 years) super balance is around $183,000.

Compounding this amount without further contributions would give us a balance of $580,507 after 15 years presuming an 8% net of fees return.

If, however, through active management of our super, we can increase the return to, let’s say 15%, the ending balance after 15 years would be…

…(drum roll)…

$1,489,082

A very rewarding difference of more than $900,000! Just from some education and time commitment to keep up with your investments.

And you can do EVEN BETTER if you manage to salary sacrifice some of your salary and top up to the maximum concessional contribution level, in most cases around $25,000 p.a.

If you are on a high marginal tax rate, let’s say 48.5%…your salary sacrifice would be taxed as concessional contribution at currently 15% giving you an immediate 33.5% points tax advantage.

Compound those numbers over the medium term and your super fund balance is going to finish in the highly sexy area of numbers.

Want to unlock higher returns from your super? Here’s the game plan:

1. Start managing your super as soon as you are employed at a level that the super guarantee kicks in

2. Choose your super fund manager wisely; usually go for a lower fee industry super fund

3. Don’t just accept the default option (a bit of everything), but actively consider what the right exposure is for the current market conditions

4. In order to know the ‘right exposure,’ start educating yourself on share investing through intensive study of books and trading systems or through employing a knowledgeable and caring mentor

5. Salary sacrifice as much as you can.

6. Pay yourself first (i.e. save into super) out of your regular salary. Don’t save what’s leftover at the end of the month as there will be nothing left over!

7. Be patient and let the magic of compounding work for you over time. Don’t expect immediate gratification!

8. Last but not least: do a St Nike – Just do it! Do it NOW! It’s never too early (or too late!).

Get Started. Don’t Procrastinate. Make looking after your investments a habit, part of who you are.

Longevity and retirement lifestyle

We have one of the highest life expectancies in the world (particularly for men strangely enough), so the old retirement strategy just doesn’t work anymore.

The way the game was played just a generation or two ago was that you would retire at the ripe age of 65 (we still have this number in mind as written in stone), you would get a gold watch as a goodbye present from the company you worked at for most of your life…then you had the courtesy to die within 2 to 3 years after retirement.

No problem funding retirement there, particularly with a high fertility rate (back then).

But now things are different.

The AVERAGE life expectancy at birth in Australia is now 82.45 years with males living on average to 80.4 years and females 84.5 years.

Think about that, average means that you have a 50% chance of living longer than the averages.

So if you retire at age 65 (in the real world people tend to retire earlier on average, somewhere around 60 – I discussed this in my previous blog), as a male you should plan for a 20 year retirement.

You’ll most likely leave your wife behind and she’ll live on average 6 years longer, so realistically your retirement funds should last 25 years +.

That’s a long time, an entire generation in fact.

The good news is that:
– Some of your living expenses will go down
– You don’t have to pay for the kids anymore (hopefully!)
– The house should be paid off by now
– Maybe you don’t need two cars anymore and
– You may spend less on fancy clothes as you stop going to the office

But then there are other costs that are rising….

Health is probably the biggest increase. As you get older, the health expenses generally rise, things just don’t work quite as well as they used to and you’ll have to see your GP and specialist much more often!

Now that you are retired, you have lots of free time on your hands and you want to have some fun!

Other than playing golf or barefoot bowling, most retirees like to travel…

…Being a grey nomad roaming the Australian bush in a caravan is relatively low cost and is a lot of fun for most people…but maybe you want to go further away and really explore other countries for a longer period of time!

(Because let’s face it, you FINALLY have the time).

But don’t think that your expenses in retirement will drop. They most likely won’t.

If you want to be comfortable in retirement (and who doesn’t want that?) you will probably spend all your saved expenses (think kids and mortgage) on health and fun.

Check out the AFSA website to see what a retirement budget typically looks like:

https://www.superannuation.asn.au/ArticleDocuments/269/ASFA-RetirementStandard-Budgets-Sep2017.pdf.aspx?Embed=Y

So how much do you need in retirement?

Centrelink gives you around $35,000 p.a. maximum as a couple. You can definitely live within this amount, you won’t starve but will probably have to eat more brown rice with cheap soy sauce and – god forbid – drink cask wine!

ASFA thinks that you need $60,000 or so as a couple for a comfortable retirement.

This allows you to:
– Maintain a decent car (not a bomb)
– Upgrade your house as necessary (occasional new kitchen and bathroom)
– Go to a decent restaurant occasionally and
– Pay for an overseas holiday

And if you want to do the REALLY fun stuff – imagine staying in the South of France for three months and becoming a local….discovering Tibet while staying in a rented house with your own driver for the summer….going on an African Safari for six weeks….or doing a 100 day cruise to the other side of the world – then you will need a cool $100,000.

A) Increasing your super fund balance:

With the recent law changes, the maximum super balance is now capped at $1.6 Million, increasing by $100,000 every year until you reach retirement and go into pension phase.

You can increase your super balance as close as possible to the maximum through high concessional contributions (now a maximum of $25,000 p.a. taxed at 15%) or through non-concessional contributions (out of previously taxed income, no contribution tax, now a maximum of $100,000 p.a. with a three year bring forward rule).

This requires delaying some consumption now for increased consumption later – not easy for many people.

B) The alternative is to work on your returns:

As discussed in my blog post about ‘Retirement Planning in the Late Career Stage’ (Click HERE to read it), the average 25 year super return is 7.4% and an average buy and hold return for a share portfolio is somewhere between 8% and 10% p.a.

Now let’s presume you don’t want to sell your house where you lived most of your family life (called downsizing) and that you want to leave some money for your children…

If that’s the case, you may want to live only from the returns of your super without touching the principal.

This is a nice aspiration and if this works out you have a tremendous amount of financial freedom as nothing really bad can happen to you financially.

Let’s plug in our target income of financial abundance in retirement of $100,000 for the sake of the argument.

If your fund achieves an average return, you would need a balance of $1,351,351 ($100,000 divided by 0.074).

If you managed to get a 10% return, you only need a fund balance of $1,000,000.

If you can pull off a 15% return, the required investment drops to $666,666.

Or put another way, a 15% return at a $1,000,000 super fund balance provides you with a $150,000 tax free income in retirement…enough for most people to have fun.

How do you get a 15% return?

To get to 15% return (or even higher – and that without leverage) requires you to stick your neck out and actively manage your super investments.

You need to know what you are doing.

Learn the game of share investing.

It’s fun, never boring and you won’t stop learning new things.

How long does it take to get to $1,000,000 balance on average weekly earnings?

Well, that depends on the starting balance, your contributions and on your return.

If you put in the 9.5% super guarantee and another 5.5% points in salary sacrifice on a $75,000 yearly gross salary (the average). Then you contribute $9,563 net after 15% contribution tax.

Starting with a super balance of $200,000 (you should be there as a couple on average in your late forties), you’ll have a $1 Million balance after 12 years, at around age 60.

You could then go into retirement, maintain a now tax free 15% return (yes, you have to stick your neck out and work on it, it’s not going to happen with buy and hold!)…and finish off with a pleasing $150,000 yearly income.

The Abundant retirement lifestyle is possible.

For the recipe to work you need to:

Start early

Salary sacrifice a bit

Learn to invest in shares and achieve at least 15% return

If you want to see how long it will take you to get to your target super balance and retirement income, click HERE to use a readymade spreadsheet and update it with your numbers.