Sent: 30-08-2011 10:30:12
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Pensions and Unitized Funds
A number of financial advisers have written to me asking that I clarify my comments about pensions.
Some of you might recall that I have long argued that total return unitized funds are inadequate. Many market linked pensions still use this style of investment.
Unitized funds suit fund managers for a variety of reasons. The accounting and member benefit tracking are much simpler than the available alternatives. It's also easier to build your costs, including adviser trail commissions, into the unit price.
For the investor however these unitized funds can be a disaster. The problem is best explained by quoting from one of my DIY Super articles in The Australian:
An investor puts $100,000 into a managed fund that has a $1.00 unit price which means they 'own' 100,000 units. Suppose that after several years the unit price has increased to $2. Their 100,000 units were worth $200,000.
If the investor wanted to pay themselves $10,000 income from this fund they would need to sell 5,000 units whilst the unit price was $2.
Now suppose that the price of the units has crashed to 75 cents but they still wish to pay themselves $10,000 income. They now need to sell 13,333.33 units.
Under this scenario units are literally walking out the door as income.
I have seen these problems for a variety of reasons in 1994, 2001, 2004, 2007/09 and 2011. On average once every three or four years.
The problem will occur wherever the investor is exposed to a market moving in the wrong direction. Most investor's are encouraged to diversify and all markets do not move in the same direction. This means there will always be a portion of most pension investment portfolios moving in the wrong direction.
In my view pensions are like small businesses. With any small business cashflow is king. A business earns income, pays its expenses and then distributes what is left to the owners via salary or other distributions.
Naturally a pension needs to do all this without any borrowing.
I'm no clairvoyant but I think that until pensions are run in this simple transparent way the problems that have regularly occurred over the last 20 years will continue to reappear at the same rate.
The Government also needs to allow the minimum pension to be determined over several years (three, four or five years) not over current market values. The purpose here is to help smooth outflows.
At the same time, financial advisers should have to project their client portfolios using a mechanism other than average returns. Average returns give a totally unrealistic insight into what is likely to happen to a client's portfolio in the future. In the US they use monte carlo simulation. I'm not convinced this is the best approach but it's better than average returns.
Ideally returns should be suitably randomly generated and show a very high percentage of all possible outcomes. Any actuary could develop a set of standard numbers that could be used across the industry.
Finally please consider purchasing a copy of this book "A How To Book Of Self Managed Super Funds". You can look at the contents page at the following link: http://www.atcbiz.com.au/r.php?r=0mjd6ne
For details of the changes made from version 4 to version 5 visit: http://www.atcbiz.com.au/r.php?r=d5xcpch
As you'll see from the list there have been many changes.
Two purchase options are available - once only subscription - $55 inc GST - or an annual subscription will gives you access to all the updates made throughout the year ($120 inc GST). The book can be purchased at the following link: http://www.atcbiz.com.au/r.php?r=5a4agqb
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