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The problem with cash.  “We can’t live off that!”

Retirees are only too well aware how far interest rates have dropped. The decline has been great for younger people paying off mortgages, but terrible for people funding retirement spending from bank account interest.   We’re at record low interest rates, and cash investments, like bank deposits, typically pay well less than 1% and many pay nothing.  This is not enough even to keep up with inflation.

However, many retirees are most comfortable with cash or bank deposits.  We see this in our clients with about 30% almost entirely invested in cash and bank deposits.

Frankly, being invested entirely in cash for funding retirement is unlikely to be the best retirement strategy.  In general, being in a diversified portfolio of assets should deliver greater returns over the medium and longer term and thus generate more retirement income.

Cash vs a diversified portfolio

Let’s see how by comparing two otherwise identical investors – one who stays in cash and the other who holds diversified investments.  What are their likely retirement finances going to look like?  We don’t know for sure, because we don’t know what’s going to happen to interest rates and financial markets. But we can make some educated estimates.

Mr Cashman decided a few years ago to take all his money out of super at age 66 and put it in the bank.  He’s now 70 and has $350,000 in the bank.

Taking into account his Age Pension, the interest from his bank account and drawing down capital from the bank deposits he might have an income of about  $33,000 per year to fund his retirement spending.

Even if we allow that interest rates may move up from their current historical lows, it’s still likely that his interest earnings will be very modest.  The average forecast we use in our model is for cash interest rates averaging 2.1% over the next 30 years.

And if interest rates stayed where they are today, Mr Cashman would earn even less. His Age Pension would comprise the vast majority of his income.

Mr Diverse took a different approach.  He’s maintained his diversified portfolio approach in his super fund.   He’s also 70 and with his 50/50 mix of shares and fixed income investments, we project a likely sustainable retirement income of $36,400 per year through age 100.

We estimate the diversified approach will lead to Mr Diverse having about $3,400 per year more Mr Diverse $3,400 more per year than an all cash approach. That’s about 10% more in annual income.

Now, Mr Diverse is taking on a bit more short-term risk to get there.  Shares and bonds in his portfolio will fluctuate in value…and that can be a bit nerve-wracking, like when COVID first hit home in March this year…a 50/50 portfolio typically dropped in value by 14% before beginning to recover.

But being on a part pension greatly reduced the risk of that decline.  When his investments dropped in value Mr Diverse was able to inform Centrelink and get an increase in his Age Pension. For each $1000 drop in his super assets his annual age pension increased by $78. This helped him weather the storm of the drop in the value of his investments.

So, while many people see cash as the “safe” investment, they’re only right in thinking that their balance doesn’t go up and down as much. Because interest rates are so low, their purchasing power gets quickly eroded by inflation.  Diversified portfolios have some short term risk but allow access to investments that may well perform better than cash over time…and so help deal with the risk of living on too low an income and having it eaten away by inflation

 

This article is provided by Retirement Essentials Representative Number: 001260855.  We are an authorised representative of SuperEd Pty Ltd ABN 88 118 480 907 AFSL #468859.  This information is not intended as financial product advice, legal advice or taxation advice. It does not take into account your personal situation, goals or needs and you should assess your own financial situation, consider if the information is suitable for you and ensure you read  any relevant Product Disclosure Statement (PDS) if you choose to make any changes to your financial situation. It is always advisable to consult a financial adviser before making financial decisions.