Tuesday 05 May 2015 by Elizabeth Moran Opinion

$1m nest egg more than enough for retirement

Published in The Australian 5 May 2015.

If you can accept risk and use some capital, you’ll be OK

Elderly couple laughing with paperwork

One of the nation’s superannuation experts, Jeremy Cooper — author of the Cooper report and currently an executive with the Challenger group — recently caused consternation among investors. Cooper said $1 million in superannuation may not be enough for a comfortable retirement at today’s interest rates.

Let me very clear — I disagree. If you invest wisely, a million dollars should be more than enough to fund a comfortable retirement for a couple.

Cooper based his comments on his valuation of the government pension, which is risk-free because it is supplied by the government and is theoretically perpetual so it never runs out.

In other words, he did his numbers on the basis that you had to use fixed income investing in government bonds to make your returns. As we know, just now interest rates on government bonds are exceptionally low. In fact, RBA governor Glenn Stevens said last week that rates were at their lowest “in human history”. 

So let’s be more realistic. None of us are going to live forever, so we do not need a perpetual income stream, and we do not need our retirement investment portfolio to be completely risk-free, although low risk is desirable.

Assuming you can accept some risk and use some capital, a million dollars is a sufficient nest. 

According to The Association of Superannuation Funds of Australia, in order to have a comfortable retirement, singles need $42,604 a year to spend and couples $58,364.

With a bit of planning — and some use of capital, which isn’t unreasonable; after all, that’s what you’ve saved for — you can achieve this income and eke out a comfortable standard of living. I have assumed you want your capital to last for 20 years, but longer periods would still work.

There are a variety of ways you can seek to make these returns, but I’d like to concentrate on restricting the exercise entirely to corporate bonds. I’ve constructed a sample portfolio.
$1m sample bond portfolio
Source: FIIG Securities
Note: Rates are accurate as at 30 April 2015 but subject to change
#Assumes inflation is 2.5%, the RBA target mid-point
*For wholesale investors only


The bond portfolio consists of allocations to 11 companies. Most are investment grade, with a credit rating of BBB- and above, the two exceptions being Qantas and non-rated ASX-listed childcare provider G8 Education. Overall returns are boosted by including allocations to these two companies.

The portfolio has been designed to try to maximise cashflow, while minimising risk but increasing return over the term deposit rate. Bonds portfolios can be designed with different goals in mind and returns and risk varies considerably. This portfolio will deliver a cashflow in the first year of $47,281; not quite a comfortable retirement for couples. 

The total projected cashflow if all the bonds are held to maturity is $1,510,341.

The portfolio has a mix of bonds with a 39 per cent allocation to fixed, 10 per cent to floating and 51 per cent to inflation linked bonds. I have a general view that interest rates will be lower for a long time, so I am happy to invest in longer-dated fixed-rate bonds, but your view may be different and you may want to adjust the allocations. The big allocation to inflation-linked bonds will help protect the value of your capital and, should inflation spiral, your returns would increase significantly. The model assumes inflation runs at 2.5 per cent, the RBA target midpoint.

I purposely included two types of inflation-linked bonds. The first is a capital-indexed bond where capital grows by the inflation rate to provide a bigger lump sum at maturity, assuming inflation remains positive. The $258,812, if inflation stays at 2.5 per cent will grow into a lump sum of about $368,000 at maturity. Countering this bond, the portfolio invests in two indexed annuity bonds — Melbourne Convention Centre and NSW Schools — that return principal and interest quarterly, so they repay capital over the term of the bond. These are very low-risk investments.

While $250,000 is repaid, the rising value of the Sydney Airport bond somewhat compensates, so that the lump sums returned to you at maturity are about $860,000. 

If you were to invest the full $1m in the Melbourne Convention Centre indexed annuity bond, it would generate cashflow of $70,872 in the first year, growing with inflation to an expected $110,342 in 2033, the last year. This would allow a very comfortable lifestyle and would fully use your $1m.

If you look at the “yield to maturity” in this exercise, it lists the expected return if you hold that bond until it is due to be repaid. If you acquired this portfolio and held it to maturity the total return is expected to be 4.61 per cent.

One way to get higher returns is to invest for longer, so while this portfolio is very low risk, there are longer terms to maturity, especially for the fixed-rate bonds. If you had a view that interest rates were going to rise steeply in the medium term, you would invest in less fixed-rate bonds and more floating-rate bonds. 

If you wanted higher returns, you could reduce or remove the Rabobank and Southbank Tafe Brisbane from the portfolio and invest in other higher-risk bonds. The reverse is also true. If you wanted a lower-risk portfolio, Qantas and G8 Education could be replaced with lower-risk bonds although this would reduce expected returns.

With bonds alone, depending on your goals, you can construct a portfolio with $1m that means you can get the returns you need.

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