Severe market downturns don't strike often, but they often undo years of hard work.
Confidence evaporates, replaced by uncertainty and fear. They prompt investors to sell at the worst possible time, locking in deep losses.
Financial planners find themselves on the front line, attempting to keep investors on the straight and narrow. It is not an easy task.
Traditional investment advice such as "remain focused on the long-term" or to "ride it out" provide cold comfort when investors are watching their portfolios fall deep into negative territory.
While there is value in maintaining a long-term perspective, it often goes completely against people’s natural instincts and inherent biases during a bear market.
Many studies have shown that despite our best intentions, most investors don't listen to this advice. It is deep within our DNA, harking back to the earliest days of humankind, to focus on short-term survival and avoid losses.
Facts versus emotion
It's hard to focus on what a market downturn means personally when media headlines trumpet billions of dollars in losses. While nobody knows what markets will do next, applying the facts to personal situations is much easier and provides some much needed comfort.
Milliman was founded in 1947 as an actuarial firm and entered the Australian market more than a decade ago, providing research, advice and risk management techniques to institutions and advisers.
Our work has uncovered important insights based on real-world situations. Older investors in particular should be aware that:
- The government Age Pension is means tested, and so provides an automatic income buffer when retirement savings decline. This provides substantial value, as shown in the graph below1.
Source: Milliman analysis
- Many retirees own their home, which has enormous untapped value. A retiree renting a one-bedroom unit in Sydney would require more than $500,000 in extra superannuation savings to fund the same lifestyle as a homeowner, according to Milliman research.
- Many retirees expect their investments to return more than the rate of inflation to meet their future lifestyle needs. A Milliman analysis of the real-world spending of more than 300,000 retirees has shown that spending declines sharply between the ages of 65 and 85.
Building better products
Many investors – and retirees in particular – were badly hurt during the GFC and are being hurt again as the coronavirus pandemic drags down economies and markets.
We know that retirees are particularly loss averse, but research also shows younger investors react poorly to market losses. The majority of Australians are risk averse by global standards, with 81% of investors under 35 seeking guaranteed or stable investment returns, according to the ASX 2017 Investor Survey.
Advisers have a deep relationship with their clients and understand the pain they go through during a downturn. Milliman’s products make life easier for advisers and their clients in markets of all kinds.
We know that volatile markets create challenges – that’s why we designed SmartShield. The managed account structure is built to work with traditional advice processes, allowing for quick and efficient responses to changing market conditions.
It is easy to explain to investors who are under pressure. When markets are more volatile, SmartShield's protection is automatically increased, providing peace of mind. When markets are less volatile, the level of protection is lowered, allowing investors to share in a potential market rebound.
Advisers can also use the risk management overlay tactically, switching it on and off as required without incurring capital gains tax.
Confidence and trust are fundamental to ensure clients feel confident and secure enough to stick with their long-term plans through a market downturn.
SmartShield can help build that foundation because it has been designed to work with how clients are, not how the investment industry wishes they were.
You can find more information about the Milliman SmartShield range at https://advice.milliman.com/en/smartshield.
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1Assumptions: a hypothetical 65-year-old couple who own their home and have $1 million in pension assets. Milliman's analysis values the age pension by discounting future means tested payments at modelled wage inflation to produce a current day value of those future payments. Other assumptions are equally possible and will give different values. There is also a range of alternative outcomes in payment amounts and values for this couple. The analysis shown focuses on the median (mid-point) of outcomes. In practice a wide range of alternative outcomes are modelled and possible for this couple.