Starting over ... Jennifer McDonell. Photo: Jodie Donnellan
For nearly 20 years, the two super fund members neatly track each other, contributing similar amounts and earning similar returns within the balanced option of their super fund. Yet, despite picking up their final pay packet within about a year of each other, they retire with markedly different balances of $444,609 and $308,716 - a gap of 30 per cent.
In this illustration, based on the real-life returns for two average members of industry fund QSuper, one person retires just before the financial crisis hits, while the other retires just after global sharemarkets capitulate.
Most of us would describe what the second member experiences as sheer bad luck. But the experts have another name for it: sequencing risk.
Sequencing risk is one of the ''big ideas'' being discussed in the super industry as funds try to work out how to better protect members the next time there's a market shock.
New approaches and products are starting to emerge as a result.
''It's all part of a broader conversation super funds are having,'' says Stephen Huppert, a partner in Deloitte's actuaries and consultants team who specialises in superannuation, insurance and funds management.
''The global financial crisis was one of the triggers, along with the first of the baby boomers retiring. That's led to a bit more introspection over investment objectives and what funds are trying to do for their members.''
With a swell of baby boomers starting to break open their nest eggs, the main focus is moving from the ''accumulation'' phase of super to the ''decumulation'' phase. The key is how to safeguard retirement savings when people have the most to lose: when their savings are at their peak in the decade before and after retirement.
''[Funds] are now starting to talk about outcomes from a member perspective, rather than just beating a benchmark or being in the top quartile [on performance league tables],'' Huppert says.
''The conversation is becoming louder and louder, and it's a very important shift in the conversation.''
Rather than asking where they rank, they're asking what the fundamental purpose of super is and it's not about wealth creation, Huppert says. ''It's about retirement income.''
A professor of finance at Griffith University, Michael Drew, works in this area and laments that until now the focus has been: ''How do we achieve the pot of gold?''
What results is the feeling of being ''rich on Friday, poor on Monday'', as retirees put away the farewell card and sit down to do the maths on what sort of income their payout will fund during 30 or so years.
OUT OF SEQUENCE
The first baby boomers to reach official retirement age know all about bad luck and bad timing.
''In their last decade of work, they experienced the bursting of the dotcom bubble, the subprime [mortgage] crisis, the GFC and they're now living through a sovereign-debt crisis,'' Drew says. ''That to me is sequencing risk.''
He is referring to the way the order of investment returns - not just the scale of them - affects your final balance. ''It's not just the average of returns over a period that matters, it's the ordering of those returns,'' says Drew, who is leading Australian research in the area.
Two people making similar contributions can earn the same average return over 20, 30 or 40 years, and yet retire with vastly different sums. That's because while the average comes out the same, the returns may have fallen in a different order for those two people.
Drew's work shows that a negative return near the end of your working life has a much larger impact than if it had occurred near the start. That's because the negative return applies to a much greater account balance.
He and his fellow researchers looked at the returns of a ''default'' investment strategy between 1972 and 2011, when the mean annual return was 12 per cent, and applied them to a 25 year old making contributions across a 40-year working life.
The returns in the order they were experienced produced a retirement balance of $4 million. However, when Drew flipped the returns so they were in reverse order, the result jumped to $5.4 million.
When he sequenced them from worst (a negative return of minus 22 per cent in year one) to best (a positive 42 per cent in the final year), the result was $17.4 million - or 46 times the $373,325 the member would have contributed themselves. Reversing that so the returns were experienced from best to worst decimated the account, shaving it to $1.4 million, or less than four times the member's contributions.
Drew acknowledges that these last two examples are extreme, with returns unlikely to occur in a precise ascending or descending order, but says they illustrate the potential impact of sequencing risk - good and bad.
A sobering result was that when Drew ran returns for 40-year periods ending in 2008, 2009 and 2010, they were ''challenging'' but not the worst order of returns in recent financial history. That honour belongs to the period 1935-74.
Add sequencing risk to longevity risk - the risk that retirement nest eggs won't keep up with increasing lifespans - and you can see why superannuation funds have their thinking caps on.
What to do? Only a minority of Australians - about 20 per cent - can afford, or are willing to access, individual advice from a financial planner, so the pressure is on super funds to provide sound strategies for members. For some funds, this is pointing to what's being called ''mass customisation'', where they attempt to tailor strategies to individual members, rather than having default strategies where one size is supposed to fit all.
The director of superannuation for asset consultancy Russell Investments, Tim Furlan, says mass customisation should be the ''minimum standard'' for super funds. ''The fact is that different individuals with different numbers need different solutions,'' he says, which he adds is already occurring overseas and could be done here.
Drew describes as ''interesting'' approaches being developed by QSuper (see story, left). In the meantime, it depends on who you talk to as to which is the ''best'' approach: bond managers say Australians are overly exposed to equities and need to take a more defensive approach to protect their retirement savings; equity managers say only growth assets such as shares can combat longevity risk. Annuities are promoted by some but dismissed by others as too expensive.
''There are lots of thoughts out there, but a lot of the ideas are conflicting,'' Furlan says. ''That's confusing for people.
''But the idea that there will be one killer solution - whether it's an equity income fund or an annuity - is probably a little fanciful.''
Drew agrees, saying part of the problem is that ''either/or'' thinking pervades much of the debate. ''We need to have more and/and thinking,'' he says.
❏ The GFC and retirement of baby boomers has put ''sequencing risk'' on the agenda.
❏ Sequencing risk is the risk that you'll experience annual returns in the worst order.
❏ A negative year near retirement has a bigger impact than one early on, and can make a major difference to your final balance.
❏ The industry is shifting its thinking from wealth re-creation to retirement income.
❏ Super funds are also looking at more customised approaches for members.
New-century tactic for age-old problem
The century-old industry super fund, QSuper, is taking the radical step of running separate investment strategies for members aged in their late 50s, even when they remain in the ''default'' option.
Those who haven't exercised their investment choice will be streamed according to factors such as age, contribution rates and accrued balance, and assigned one of a number of strategies according to their circumstances.
''The vast majority of super funds have a single default investment strategy,'' the chief investment officer of QSuper, Brad Holzberger, says of the change. ''Whether you're 20 or 60, regardless of account balance, you will get the same investment strategy unless you become a 'choice' member.''
As is the case with many other funds, more than 80 per cent of QSuper members are in the default option, and Holzberger says they're entitled to expect the fund's trustees to act in their best interests.
QSuper will eventually roll out this form of mass customisation to all members in the default option, but decided to start with those in their late 50s because they face the greatest risks - including sequencing risk.
''The impact of the GFC on our members brought this into stark relief … we were finding absolutely material differences between cohorts,'' Holzberger says.
''We wanted to put in place processes to make sure we handled this better in the future.''
What the public service-focused fund knows about its senior members is that they have a wide range of circumstances. Some have worked continuously as government employees - with a higher contribution rate than for the general population and large balances they don't want to put at risk. Others, such as nurses, may have broken their careers to raise children and have lower balances they need to boost.
So the new age-based strategies for the late 50s won't necessarily be about ''de-risking''.
Nor will there be a rigid template tied to retirement date, as was the practice of the ''target-date'' funds that performed miserably in the US.
The weakness of target-date funds is that they engineer everything around the member's age, Holzberger says.
''A member's age is a useful piece of information, but it's only one element of the full suite of information accessible to us. There's nothing fixed, there's nothing that's presupposed.''
And the strategies will be reviewed regularly in line with changing circumstances, he says.
''If market risk changes, we are free to respond on behalf of this cohort … we are very conscious that we have to respond to the times that are in front of you.''
In another radical step, QSuper has removed its default fund from the ratings ''league table'' process, not because it hasn't been doing well - it was among the top funds - but because it wanted to be able to think and act freely.
''Compared to other funds we will look different - but we're comfortable with that,'' Holzberger says.
THE global financial crisis landed smack in the middle of Jennifer McDonell's divorce settlement.
McDonell went from expecting to live debt-free after receiving her share of the family's property, super and investments, to having to move her home and new business to a cheaper location - and still ending up in debt.
''My divorce started in 2007,'' she says. ''Then the GFC struck. Property values dropped, superannuation values dropped, and the share portfolio halved.''
She estimates her settlement was probably half of what it would have been otherwise.
At age 59, and with no super of her own, McDonell is starting over as a property stylist, setting up the business Style My Home in her new home town of Bendigo, and hoping to soon be able to buy outright a ''renovator'' property.