More people are making choices in superannuation.
But their decisions could be cutting their balances by up to 32 per cent, or hundreds of thousands of dollars, in retirement.
Research House Rice Warner has cautioned that a social media-driven trend to move away from the default super option provided by employers to choice funds can leave people unprotected.
“The default system is covered by MySuper laws which require funds to act in members’ best interests,” said Steve Freeborn, Rice Warner’s client relations chief.
“Choice funds must just meet objectives,” Mr Freeborn said. “They could be having a reasonable chance of making returns equivalent to the CPI plus 4 percentage points or an index plus 10 per cent,” Mr Freeborn said.
Going down the choice path can see people signed up to funds early in their careers which may meet their stated performance objectives, but the effects of high fees and sub-optimal returns result in retirement balances significantly below what would have been earned in default funds.
The chart compares a typical default fund, in this case AustralianSuper, against one of the new-entrant, for-profit funds that have come into the market in recent times aiming at particular cohorts, such as millennials or women.
The fee structure of such funds means they effectively target and achieve lower rates of return, Mr Freeborn said.
In this example the default fund targets 4 per cent above the CPI, while the new entrant’s fee structure and investment strategy effectively delivers 2.5 per cent.
That translates into a 31.7 per cent lower return over the working life of someone joining at 25 on an income of $75,000, or a balance deficit of $296,400.
Increasing engagement with super has been an aim of the industry. While greater levels of engagement is becoming a reality, it can have its downsides.
“Engagement is being mass marketed through online and social media,” Mr Freeborn said.
“It can result in people joining choice funds that don’t have the capacity to invest in long-term assets [like infrastructure and private equity] that deliver higher returns.”
The choice phenomenon is growing strongly.
“When My Super laws were introduced in 2013, 49 per cent of all pre-retirement super was in choice assets. By 2016 this had risen to 64 per cent,” Mr Freeborn said.
While some of this growth is accounted for by the assets of a few, often sophisticated investors using self-managed super funds, “there is growth in absolute numbers as well. New funds [often aimed at young people] are getting traction and gaining tens of thousands of members, ” he said.
Choices can be driven by accountants or financial advisers early in the course of working life and not reviewed.
“Choice is all right if it is informed choice, but when people’s choices are driven by emotion rather than being informed, it’s a problem,” Mr Freeborn said.
“When you’ve got little money, a 1.5 per cent difference in returns makes no difference, but with the effects of compound interest it makes a lot of difference over time,” Mr Freeborn said.
David Whiteley, CEO of Industry Super Australia, said the default sector was a sensible choice for many people.
“The evidence shows that the choice sector continues to underperform default funds, leaving those members in choice products worse off come retirement.”
“It is counterintuitive for consumers to select a super fund that under-performs their current fund or alternatives in the market. Yet despite this the banks continue to push ‘choice’ products, ” Mr Whiteley said.
Greater regulation could help.
“Choice funds should be subject to the ‘best interests’ test,” Mr Freeborn said.
The New Daily is owned by a group of industry super funds