It has becomes obvious Australians don’t have all the tools they need to reliably fund retirement.
While various inquiries are looking into the tax and financial systems, not enough attention is being directed to filling product gaps — a critical one is for safe, simple and easily accessible bonds to help investors keep up with increases in the cost of living.
Finance author Burton Malkiel suggested that for defensive reasons investors should have their ‘age in bonds’ — that’s 50 per cent or half your investments if you’re aged 50. While perhaps an oversimplification, as well as overly conservative, for many it is a lot different to what they have. Ask most Australians what a bond is and you’ll get a blank stare. This despite bonds having been around three hundred years earlier than shares and the global bond market double that of the share market.
In the past many Australian investors were able to get away with using high interest savings accounts and bank term deposits as a proxy for bonds. When the Reserve Bank of Australia (RBA) reduced its benchmark rate it cut savers’ income in half, compounding the shock of declining share markets and dividends. Now as some chase after the last financial year’s impressive 10 per cent return from Australian bonds, they could be hurt once again if bond prices go down as interest rates rise.
Australian investors really don’t need income tied to the movement of interest rates. What they need is income that adjusts to increases in the cost of living. After all, maintaining a real or inflation adjusted standard of living in retirement is the goal. Over the last 100 years in Australia, traditional bonds failed to help investors keep up with cost inflation at least 20 per cent of the time, and it has been even worse for cash deposits. Neither sound like terribly defensive investments.
Earlier this year I wished for the reintroduction of the Australian savings bond, especially a retail inflation-linked version. Others have supported the call for inflation-linked bonds, including institutions interested in selling annuities. It is pleasing that last month the Government’s bond issuer, the Australian Office of Financial Management, announced it was dusting off its playbook and reintroducing Treasury Indexed Bonds (TIBs), beginning in late September or October this year.
While this is a good step, it has a couple of shortcomings.
First, retail investors need an ‘interest indexed’ bond that pays an income regularly adjusted according to the consumer price index (CPI), not a lump sum adjustment paid many years later on maturity, which these capital-indexed bonds do.
Second, these are only being offered to institutional investors like insurance companies, fund managers and large superannuation funds. Most won’t trickle down to needy and bruised retail investors and certainly won’t help those Australians who need a simple savings product.
To help advance this cause further, it may be helpful to picture, literally, what an Australian ‘cost of living adjusting bond’ might look like. The brochure for this Australian Savings Bond could point out:
- these are issued and guaranteed by the Commonwealth of Australia;
- they pay income four times a year adjusted for recent inflation, not interest rate settings;
- these bonds can be purchased and redeemed online via a proper government website, just like investors can in the US and UK, and not via a back-door facility at the RBA;
- lower value denominations are also available in certificated paper form over the counter from banks and the post office to help out the more disadvantaged or computer averse;
- no fees are chargeable by assisting intermediaries, although there is no reason why the Government could not pay a transaction ‘commission’ to reimburse this public service;
- these bonds remain on issue for 10 or 20 years, however, they can be redeemed once a year on the anniversary of their issue and in cases of financial hardship at any time; and
- other bond series are available. Where ‘C’ stands for cost of living or CPI adjusting there could be ‘F’ for fixed or floating rates, ‘I’ for infrastructure and perhaps ‘B’ for lottery-like bonus bonds.
Calling these ‘cost of living adjusting’ bonds might better explain how they work but runs the risk of being associated with a famous soft drink. The Government should also be careful rushing in traditional ‘nominal’ bonds (type F), as these might compete with deposits and perhaps destabilise bank deposits.
Inflation-linked bonds are currently available directly to US and UK savers. Experts trace their history as far back as 1780 America, where they were used to guarantee soldiers’ wages in the state of Massachusetts.
One of the advantages of creating a simple product that is closely aligned to investors’ needs is that it may reduce the need for advice, especially among those of lesser means who may find advice difficult to access. It also supports independent investors who struggle to find safer alternatives to cash savings and are lured into more complex and risky investments.
Inadequate financial education and excessive complexity work against the average Australian. Introducing a retail, inflation-linked savings bond will work for them. I say bring back the Australian Savings Bond.
Dr Doug Turek is the managing director of private wealth advisory firm Professional Wealth, and founder of financial information service Wealth benchmarks. He will be presenting at the Financial Planning Association’s national conference in November, 2009.
