New defensive advice approach needed to solve cash conundrum

As a result, as record-low interest rates punish cash returns, innovative protected retirement strategies are emerging as a new defensive solution for retirees.

Allianz Retire+ CEO Matthew Rady said that retirement strategies that offer downside protection have traditionally been used in the equity component of portfolios to safeguard against sharemarket volatility.

“They haven’t been thought of as an approach that can potentially deliver higher returns than traditional defensive assets,” he said.

In this environment, Mr Rady said, retirees and their advisers need a new approach to generate returns in excess of cash. 

“With the cash rate near zero, retirees who have a lot of savings in cash risk going backwards financially in real terms and having a significantly lower standard of living this decade, compared to a pre-GFC environment,” Mr Rady said.

“Rolling over one-year term deposits — a practice favoured by some retirees — is particularly problematic.

“Those who persist with this strategy may be in for further pain. Too many retirees feel there is no alternative and have automatically rolled over their term deposits into lower rates.”

As many retirees favour cash because they want the peace of mind that protection and return certainty offers, Mr Rady noted the downside in the current environment is minuscule returns.

From a high of 8.25 per cent after the GFC, term deposit rates have fallen to just 0.3 of a percentage point, according to recent RBA data. After accounting for inflation, the real return on cash is negative.

“With interest rates at unprecedented lows, and unlikely to head substantially higher anytime soon, retirees need the defensive component of their portfolio to work harder for them,” Mr Rady explained.

“They need to ask: how can I get a better return than I’m currently getting from my term deposits or cash while ensuring there is still sufficient downside protection for my retirement savings? We believe protected retirement strategies that are backed by a life company are part of the answer.”

Utilising the defensive approach

In an example provided, a 68-year-old retiree who inherited $300,000 after the loss of a parent wants that money protected and separated from other assets.

If that $300,000 was invested in a term deposit over seven years (from 2014 to 2020), the ending balance would be $353,434, with a cumulative return of 17.81 per cent.

Hypothetically, and using past performance data, Mr Rady noted had the retiree utilised a protection retirement product, exposed to market-linked returns, the ending balance on that same seven-year period may have been $384,285, with the cumulative return 28.1 per cent excluding taxes and net of fees.

“This case example utilising a zero per cent protection ‘floor’ strategy within a seven-year protected retirement product highlights the benefits of incorporating protected retirement strategies into a portfolio, to potentially lift returns in a low-rate environment,” he explained.

“This will mean that if an adviser is looking for a higher rate than, say a 0.3 [of a percentage point] per annum return, a maximum potential return of 2.15 per cent per annum on a zero per cent protection floor option might be worth consideration.”

Mr Rady cautioned that there is a potential limited downside risk involved, as returns are generated from having linked exposure to local and international shares. In the example of using a zero per cent protection floor, if linked markets were to post zero per cent or negative returns, investors could be subject to a maximum downside loss of 0.8 of a percentage point in a year.

“A protected retirement strategy is not risk-free, nor is it a cash or term deposit. It’s a completely different longer-term product, with sharemarket-linked returns. We don’t see this as a complete portfolio solution, nor is it a replacement for fixed income in a defensive portfolio. It’s rather one component of a good overall retirement strategy,” he said.

“It’s definitely worth advisers assessing the cash component of their defensive portfolios and assessing a retiree’s risk appetite to alternatives in this environment if a retiree is prepared to weather a potential downside loss of 0.8 [of a percentage point] per annum, the flip side potential could be up to seven times the current term deposit rate. 

“That could make a huge difference to returns on part of their defensive allocation over time — and to their standard of living.

“People in retirement get peace of mind from having downside protection, which is the sense of safety they feel in cash, but potentially a higher return than cash, generated from having exposure to local and international shares. In this market, every extra point of return counts.”