Another Perspective on the UK Pension

Here is another way of looking at the UK pension, which I have applied to contribute to. Our net worth not counting our house is about AUD 6 million. Using the 4% rule, we could withdraw AUD 240k per year. Currently, our spending is below that, which is why I have been thinking about retirement. The pension would add almost AUD 20k per year to that.* And the contributions would only be around 1/2% of the 6 million.

* This depends on how much tax we end up paying in retirement. Based on last year's tax return, if I stopped working I would earn AUD 56k p.a. So, my marginal tax rate would be 32%, which would apply to this additional income. That seems like a really high rate at such a nominally low income.

UK Pension

 

This was totally not on my radar. When procrastinating on Wednesday, I saw an article in the Fin Review about how Australians who had worked 3 years+ in the UK could claim a UK pension by making extra contributions from overseas. The article explained that UK citizens in Australia could also do this. You need a minimum of 10 years of contributions to get the pension. If you have 35 years of contributions, you get the full pension of £11,500 per year currently. Unlike Australia, there is no means testing.

More than 35 years ago, I got letters from National Insurance in the UK, (I was living in Israel most of the time then) asking whether I wanted to make voluntary contributions to the UK pension. At the time, I was an undergrad student and the payment was a good chunk of money for me. I discussed it with my father. He argued that I could make more payments later and anyway who knew if there would be a state pension when I was ready to retire. So, I didn't make any contributions. So, I knew about voluntary contributions, but didn't realize I could be making them now. Most importantly, I didn't realize what a fantastic investment this is!

The main point in the AFR article is that up to 19 April this year it is possible to make contributions for the 12 years between 2006 and 2018. After this date, it will only be possible to contribute for the previous six years.

So, Wednesday evening I set up a digital ID on Government Gateway - the UK's equivalent of Australia's MyGov. It turned out that I could use my Australian passport to identify myself. My UK passport expired in 2024... This allowed me to check my record of contributions. Then, this afternoon, I submitted my application to make voluntary contributions. They will process the application and then send me payment details. Mainly, I had to enter information about my last UK employer and the employers I have had since I left the UK. Luckily, there are only three of these and I have a good idea of the dates I started and finished at each one.

Who knows whether they will process the application by the deadline for adding the extra 12 years of contributions, but at least I tried.

It turns out that I have 7 full years of contributions. They even counted years when I was over 16 and in high school! So, if I could add the 12 extra years, the most recent 6 years, and the 7 years till I am 67, I will have a total of 32 years, which will give me 91% of the full pension! Even without the extra 12 years I would have 57% of the full pension.

OK, so why is this such a fantastic investment? Each additional year of contributions buys £11,500/35 per year in extra pension or £329. The most recent years cost only around £900 in contributions! So, you are buying an annuity that starts at age 67 paying an annual dividend of 37%! All your contributions will be paid back by the time of your 70th birthday, and the payments after that are pure profit! If I live to the same age as both my parents did then the internal rate of return would be a real (i.e. assuming zero inflation) 17%. That's not far behind our track record with 3i (III.L).

This is a no-brainer investment.  

P.S. 21 March 2025

My brother says that if they get back to you after the deadline they will still let you pay as long as you lodged before the deadline. Good news if true.

Where We Are at With the VSS

The latest episode. I met the director on Thursday. They didn't try to discourage me from doing it (I didn't expect they would). They even noted that they have at least a couple of other people who teach and research in my exact field. We are the top place for this in Australia. We also discussed other options included a transition to retirement plan, where you work part-time till a set retirement date at a maximum 3 years in the future. The director saw this plan as tied to a specific "project", which isn't something in the plan as described by the university. The key aspect in the university description is that the university keeps paying employer contributions to Unisuper at the full time rate even though the worker is now working part time. This is critical for people on the defined benefit scheme who otherwise lose a lot of money if they switch to part-time work.

The other option we discussed is simply working part-time. The director wouldn't commit to a specific reduction in salary that I need to take in order to reduce my teaching load. Instead, they said I should talk to my department head (HoD).* But they did say that all expectations needed to be adjusted and not just the teaching expectation. What does this mean? Academic staff are allocated a nominal percentage workload. In my case it is 40% teaching, 40% research, and 20% service. So, the director is saying that each of those percentages need to go down, not just the teaching one. This is totally expected. Having been a HoD myself, I knew that they couldn't make this decision by themselves. But what they can do is look at their teaching plans and see how it would work.

So, on Friday I talked to the HoD on the phone, who was very positive about the part-time plan and said there are two people who would be interested in teaching one of my courses. The HoD will now go back to the director to negotiate the percentage cut in FTE. The HoD is going to argue for a 30% cut. I think the director wants 50% but wouldn't say so. Maybe I'll end up at a 40% cut?

On Tuesday, there is an information session on the VSS, which I'll attend.

I have discussed this a lot with Moominmama. At one extreme we talked about taking the VSS and moving somewhere cheaper and doing homeschooling. In Australia, the lower the cost of living the worse the quality of public schools and there might not be a suitable private option.** At the other extreme we are looking at doing the part-time option.

I've debugged my simulations more and the VSS is equivalent financially to working part time to the end of 2028. After that, one year of part-time work adds 1.1% to net worth. Full time work adds 0.8% per year on top of the part-time option. The differential is because of progressive taxation.

So, why not just take the VSS? The main reason comes down to going cold turkey from an AUD 200k plus salary to depending entirely on investment returns.*** This month has been our worst in investment returns since June 2022. I have been very stressed out by the combination of that and the need to make this career decision. Moominmama thinks I will be very stressed out and maybe make bad decisions if I take the VSS. So, the lowest stress path is to ease into retirement gradually. In theory, the VSS gives you a pile of cash, so that you don't need to depend on investment returns for more than a year. But the temptation is to chase yield on that too...

* The director heads a "school" that comprises 4 academic departments. 

** In particular, coastal areas outside the big cities are notoriously areas of low socio-economic status and high unemployment. Here are the socio-economic profiles of our nearest public high school in Canberra:

and Bateman's Bay High School, on the coast near Canberra:

These numbers are relative to Australia as a whole. The main private school tbere only has 28% of its students from the top quartile and its performance is similar to the average school in Australia. At our children's school 80% of students are from the top-quartile! I think that is likely too far in the opposite direction 😀
 

*** Around AUD 245k pre-tax including employer superannuation contributions.

 

VSS Update

I now have a meeting lined up with my boss and discussed the whole thing with a colleague who took a similar package in 2020. He said that there weren't anything to know really that isn't on the website and the main thing are the psychological issues involved in retirement in general but also the sudden and fast pace of retiring under a scheme like this. I have been debugging and improving my simulation. Now there is no financial difference between taking the package and working half time from the middle of this year till the end of 2027. After that, each additional year of half-time work adds 1% to net worth!

The university has an existing "transition to retirement scheme" as well. Under this you commit to retire at a date not more than 3 years out and then step down your hours while the university pays your superannuation contributions at the full time rate. That wouldn't be much different to taking the package. Maybe 0.5% extra net worth and a lot of work....

The website mentions that there might also be an early retirement scheme but that the ATO needs to approve of it still. So, I sent an email to HR asking what that would be like.

 

VSS

VSS stands for "Voluntary Separation Scheme". The details were announced this afternoon. There are three weeks to apply for it from today. They are offering 3 weeks pay per year of service as a severance payment. That means I'd get about 3/4 a year's pay in a tax advantaged way. So maybe a year's after tax pay. I estimate now that net worth in 2029 would be only 5% lower than it would otherwise be. It's beginning to look like a no-brainer. Next step would be meeting with my director.

P.S. 8:50pm

I sent the email to my director about discussing the VSS and other options. Apparently, there is also a retirement scheme they are progressing with the ATO and the FAQ discusses working part time etc. I ran the numbers on the payout calculator they provided. Including annual leave and long-service leave, my estimated pay out is AUD 269k. There would be an estimated AUD 40k of tax on that.

Voluntary Redundancy

So my employer announced a couple of days ago in the weekly newsletter that there will be a voluntary redundancy scheme. The details won't be announced until next week. Up till now they said that redundancies would be based entirely on determining work needs and budgets going forward and there would be no voluntary redundancies. Moominmama might also be made redundant mid-year, as her employer is also cutting and she is under-employed in her organization currently.

So, I did a simulation of what would happen if we both quit mid-year,* I got an AUD 75k payout (1 week's pay per year of service + 25k for long service leave etc.) and retired putting my transfer balance cap into pension mode. At the end of 2025 there is no real difference, as my pay is largely replaced by the payout. At the end of 2029 our net worth is 7% lower than it would otherwise be if I followed my original plan to work half time from next year until then.**

At first, when I told Moominmama this result she said: "Why are we working anyway then?" When I mentioned that I needed to stress test the result for different rates of return etc. she began to say it was too scary that we wouldn't have a salary coming in and I shouldn't take voluntary redundancy. But with that attitude I wouldn't retire till our youngest child completes grade school in 2037 when I will be 73!

In any case, I might yet be made compulsorily redundant. Our school (group of departments) has been given a salary budget for this year that is around 10% lower than the salaries we are paying... 

* To get a rough estimate you don't need a simulation. Just work out the after tax salary and superannuation you are giving up by retiring now net of the redundancy payment and divide it by current net worth. That tells you how much more % you would have in net worth at the end of the period of foregone salary.

** Net worth in 2029 would still be AUD 1 million higher in real terms than at the end of 2025 despite being retired. This is because our current spending is only 2.9% of our net worth (not including housing equity), which is well below the classic 4% rule.

P.S. 21 February 2025

Heard today that the window for applying for voluntary redundancy will only be three weeks from 25 February when the details will be released.

Investments Review 2: Mature Superannuation Fund Investments

We each have an employer superannuation fund. Moominpapa has Unisuper (Sustainable Balanced Option) and Moominmama PSS(AP) (Balanced). Each is a diversified fund. PSS(AP) has more private equity, hedge funds, and real assets, while Unisuper is more public stock focused, particularly international stocks. These are two of our biggest investments. Unisuper is 10.0% of net worth and PSS(AP) 8.3%. And they have performed fairly well. Unisuper has an IRR of 10.5% and PSS(AP) 8.9%. We need to keep making contributions into these funds if we want to get the full employer superannuation contribution (I think). But we could roll over some of the money to our SMSF if we wanted. In fact, I have begun to do that using a transition to retirement pension. You can already see the effect in this graph:

 

That's the move down in the red line (net investment) on the right. This is classified as a mature investment, because profit (golden line) exceeds the red line. Back in the 1990s I contributed to Unisuper (or SSAU in the early days). You can see that saving at the left. But then I rolled it over into Colonial First State's retail fund, which allowed me to invest in a geared share fund, greatly expanding my investment. Eventually, I rolled that over into the SMSF. As will usually be the case, almost all the profit has been made since 2012 and the majority since the pandemic low.

We have "only" been investing in PSS(AP) since 2007. Again, we made no money till 2012 and the majority since March 2020:

 

The net investment or input curve is now sloping down because:

• Moominmama is now working part-time
• We only make employer contributions to the fund and make additional contributions for her to the SMSF.
• Profit is computed pre-tax and in order for the value (green) to be equal to the sum of profit and input we need to deduct the imputed tax from the input series.

So, we are kind of divesting from this fund too. 

This is what mature investments will look like - profit is still climbing though we are pulling money out of them.

The Banana Zone

So I wore this shirt to lunch with a couple of friends today:

After the first friend left, I was saying how I hated buying clothes (because it is hard to get stuff that fits), but the shirt I was wearing was new. So, he asked me about the Banana Zone. After I explained, he asked whether he should invest some of the extra money he wanted to put into superannuation earlier or wait for the end of the financial year. I told him that it really mostly applied to cryptocurrency. He mentioned that he was trying to reach the transfer balance cap. I said: "I've gone over that". He was surprised as I had only had $1.6 million when we had recently discussed this.* "What did you do?" "Cryptocurrency!" Then he was like: "You need to sell now, Warren Buffett would never do that." (I'm paraphrasing). I said that I did plan to sell this year... "Why are you making such risky late moves?" "To buy a $4 million house".

The $4 million house is an inside joke. We recently visited our friends' newly built house that was mentioned in the linked blogpost. It cost them a total of $4 million in the end, but probably isn't worth as much now. Buying and knocking down an existing house destroys value and property prices at the high end here have softened.

* At that time, I said I didn't want to make much more in non-concessional contributions, as I'd probably hit the transfer balance cap by investment gains anyway, and Labor's plan to tax balances over $3 million was looming.

The Australian Reports on Superannuation Fund Performance for the 2024 Calendar Year

The Australian reports on the best performing super funds for 2024. They focus on lifecycle, balanced, and sustainable options. I am sure there is some retail super option invested in international shares that did better than these. How did we do? I compute our SMSF returns pre-tax, while super funds report post-tax results. But anyway, our SMSF gained 34.1%! Estimated pre-tax numbers for Unisuper and PSS(AP) balanced options were 14.3% and 13.4%, respectively.

Went Over the Transfer Balance Cap

Intramonth, I've blasted through the transfer balance cap. This is the limit of AUD 1.9 million that you can transfer from an Australian superannuation account into a tax free pension when you retire or reach 65 years old. I'm now nearer AUD 2 million. The important thing is that when you exceed this limit you can no longer make "non-concessional" (post-tax) contributions to superannuation. However, I can continue to make recontributions to superannuation from my transition to retirement pension until the end of June this year. This is because this rule depends on your balance at the beginning of the current financial year, which in Australia starts at the beginning of July. But if I do stay over the AUD 1.9 million level on 30 June this year, I won't be able to make non-concessional contributions to my account next financial year. Instead, I will make them to Moominmama's account.

P.S. 20 January

The Australian is reporting today that the transfer balance cap is likely to be raised to AUD 2 million next July.

Regal Funds Share Purchase Plan

Regal Investment Fund (RF1.AX) is doing a share placement and a share purchase plan (SPP). Under the SPP you can buy up to AUD 30k of shares at the recent NAV of AUD 3.41. They have made an official 20% average rate of return since inception. My internal rate of return is higher than this. So, I think I should take up all of this, but don't have anything I want to sell in the SMSF's brokerage accounts. I could either make an additional AUD 30k non-concessional superannuation contribution to my account or withdraw something from one of the SMSF futures investments. It's probably the last chance to make non-concessional contributions to my account, as I could hit the balance transfer cap of AUD 1.9 million by 30 June 2025. Also, the futures investments have been weak recently, so I think they might see a return to the mean in terms of performance and selling now might not be a good move.

Transition to Retirement

I am thinking of setting up a transition to retirement pension (TTR pension). This allows you to receive regular payouts from your superannuation once you reach the age of 60 even though you are still working. I will be 60 years old in about 6 weeks time! There are lots of strategies this can be used. In my case, I am thinking to continue working full time at least for the next year and to recontribute all the payout to superannuation as non-concessional contributions (post-tax contributions). This has two advantages: 

1. It will convert money that was contributed as concessional contributions (at the 15% or 30% contributions tax rate) and earned as investment returns into non-concessional contributions. If my children inherit some of my superannuation when they are past the age of 18 they then won't need to pay tax on this part of the payout. The "death tax" is only on concessional contributions and fund earnings.
2. Once I hit the transfer balance cap, of currently $1.9 million, I can contribute the money to my wife's superannuation instead. I am currently at $1.7 million and she is at $800k. So, there is still a lot of unused capacity there. 

When you retire or reach age 65 you can transfer money up to the transfer balance cap into a zero taxed pension account. Money over the limit stays in an accumulation account where earnings are taxed at 15% (10% for long term CGT). The TTR pension does not affect the calculation of the transfer balance cap unless you are still holding it at age 65 when it becomes a regular tax free pension account.

My Unisuper account is close to 100% concessional contributions and earnings. So, I would start with that and transfer $600k to a pension account and pay out 10% of it each year, which is the maximum withdrawal rate. You have to leave some money in the accumulation account to receive new contributions... But actually 60% of my SuperGuardian account is also concessional contributions and earnings, and so it would make sense to transfer $400k from that into a TTR pension account too. So I would be withdrawing $100k per year and recontributing. The reason I wouldn't withdraw the maximum annual non-concessional contribution level of $110k is because my employer contributes more than the allowed cap on concessional contributions each year and the excess becomes non-concessional contributions.*

The downside to recontributing to my wife's superannuation is that I could make those contributions from non-superannuation money resulting in getting even more money into super. After all, even if you have more than $1.9 million in super, the amount above the limit is concessionally taxed compared to non-super investments.** But right now I am not making those contributions. Instead, I have been building up a pile of cash offsetting our mortgage. This is partly to reduce our interest bill but also part of a plan to buy a more expensive house in the future. So, as long as I was planning on saving to buy a house, I wouldn't make non-concessional contributions to her account.

Anyway, I sent an email to Unisuper yesterday expressing my interest in TTR pensions and asking what the next step is. 

Originally, I planned on switching to half time work when I reached 60 years old, but I seem to have fallen victim to the one more year syndrome. Seems silly to sacrifice $120k in pre-tax salary and superannuation just to have a bit easier time in the teaching half of my year. Also, my university is enacting a major cost-cutting exercise that likely will see more than 500 jobs cut in total. Academic jobs will not be cut till next year. They are not putting in a voluntary redundancy scheme. But I figure that if I am made redundant then I will get a bigger payout if I am still working full time. I could be wrong about that.

* That's why my Unisuper account isn't 100% concessional contributions and earnings.

** The government plans to tax superannuation in excess of a $3 million threshold at higher rates that include unrealised capital gains. But I think the senate will not pass that legislation and we are still a long way from the $3 million level.

Should You Keep Your Superannuation in Accumulation Mode?

The accepted wisdom is that as soon as you retire in Australia and are over 60 years old, or as soon as you hit 65 years old even if you are still working you should shift your superannuation from accumulation to pension mode. You can transfer up to $1.9 million per fund member into pension mode currently. Investments in pension mode have zero tax. This is in comparison to 15% tax in accumulation mode with a 1/3 reduction for long-term capital gains.

But what if you have a lot of investments outside of superannuation? These are highly taxed and so doesn't it make sense to run these investments down first to reduce your overall tax? In pension mode there are required minimum withdrawals each year. If you don't spend that money it is simply added to your highly taxed non-super investments. So, despite not having to pay tax on your money in super, you are transferring more and more money out of super into your taxable accounts. Does it make sense to wait till you have spent your non-super investments?

I ran a simulation in my long-term projection spreadsheet. This isn't a Monte Carlo simulation. I just assume my historical average rate of return over the last 20 years applies into the future. I assume that I retire at age 65 and convert my super to a pension and Moominmama converts her super to a pension at age 60. She stops working when I do. I also assume that the tax rate on investments outside super is 20% of returns (without any attempt to define realised and unrealised gains) and in super in accumulation mode is 12.5%. Both are probably at the high end of what might actually happen. But the contrast with zero tax in pension mode, makes pension mode more attractive relative to accumulation mode. The simulation runs to 2050.

I also run a simulation where all our super stays in accumulation mode. This no pension scenario has 8% more assets in 2050 than the pension scenario.

This modelling is still not that realistic. I assume that all our superannuation can be moved to pension mode, even if we exceed the $1.9 million threshold. Also, we are likely to make more non-concessional contributions to Moominmama's account before 2029 and I assume we don't. I'm think that these tweaks won't change the fundamental result. We would have to have a lot less non-super investments to change the conclusions.

Superannuation Returns for the 2023-24 Financial Year

The Australian reports on the performance of superannuation funds for the just completed financial year. This year, retail funds tended to perform better than industry funds because of their higher allocation to public stock markets rather than private assets. How did our SMSF do by comparison? I don't actually compute comparable after-tax performance figures, which are how superannuation returns are reported.* Public offer funds make an allowance for future tax payable, which includes capital gains tax if the assets are sold. This means that members who withdraw funds don't push tax liabilities onto those that stay. This is unlike a regular unlisted managed fund where tax is at the investor level and attached to distributions... 

So, instead I estimate what the performance of our employer funds might be pre-tax. This probably over-estimates the performance of the employer funds, but reconciling tax expected with tax actually paid on our SMSF would be hard work. On that basis, the SMSF returned 9.54%. Unisuper returned 10.89% and PSS(AP) 10.55%. Both the latter are balanced funds. Even though we underperformed for the year, we are still ahead overall since inception:

PSS(AP) has, however, inched ahead in risk-adjusted performance. It now has an information ratio (Sharpe ratio with zero risk free rate) of 1.02, versus 0.96 for the SMSF. Unisuper is on 0.83. 

Since inception, the SMSF has returned an annualized 7.9% pre-tax versus 6.44% for Unisuper and 6.63% for PSS(AP).

* Reported performance does deduct administration, audit, ASIC fees etc. As an example, for the year to 31 December 2023, Unisuper report a return of 10.3%, while I estimate a pretax return of 11.15% for the fund.

Revisiting Inflation vs. Investment Returns

In January, I posted about how much of investment returns were being taken up to cover the effects of inflation. I fitted a quadratic curve to monthly investment income to smooth it out and compared that to the current inflation rate multiplied by our net worth. It didn't look good. How are things looking now that inflation has come down a bit?

On this graph, I have also added fitted saving and an alternative calculation of expected investment returns. To calculate this one, I fitted a linear trend to the monthly percentage rate of return and multiplied that by net worth. It doesn't include any gain in the value of our house, and turns out to be relatively more conservative. On the other hand, the "boiling point" where investment returns exceeded saving was still around 2012.

The picture has improved in the last few months as inflation has declined. Using the more conservative measure of projected investment income we have a surplus above inflation of around AUD 15k per month, which is in the ballpark of our current spending not counting taxes. If inflation stayed low, retirement should be feasible. But there is still huge uncertainty around future inflation, investment returns, and spending, which continues to make me cautious.

SMSF Portfolio Allocation

As there has been a lot of recent change in the SMSF portfolio allocation, I thought I would have a detailed look at it. The last time I updated this spreadsheet was in August 2022, when the portfolio was quite different.

We also are long two Australian Dollar futures contracts. The asset classes are where each investment is classified for my reporting based on asset classes. PBDC is equity of private credit lenders, Defi Technologies is a crypto asset manager, and bitcoin isn't mostly actually futures. So, their designated asset classes are a bit to a lot misleading. Regal is actually only about 50% hedge funds now, with real assets (water and royalties), private credit, and venture capital in the mix. In my reporting on asset classes I break it down along these lines.

So there is about 30% managed futures exposure, 21% crypto exposure, about 17% private equity, 16% property, 15% hedge fund with some real assets thrown in, and 1% cash.

There wouldn't be much point in having an SMSF if the portfolio looked like a typical industry fund 😊. 

We pay only 0.26% per year in admin fees to SuperGuardian.

Checking in on the SMSF

 We have now been running an SMSF for almost three years. How is it doing?

The obvious benchmarks are our employer superannuation funds - Unisuper and PSS(AP). All these numbers are pre-tax. I probably over-estimate the tax paid by the funds, while I know the exact amount of tax paid by the SMSF. So the funds have a bit of an advantage here. 

The SMSF got a good start after which it gradually trudged higher. The two industry funds both declined substantially in 2022 and then recovered. PSS(AP) is almost catching up with the SMSF now.

The SMSF has had lower volatility than the two industry funds, though, at 1.85% per month, its standard deviation is only marginally lower than PSS(AP) at 1.87%. Up and down moves are both penalized using this metric. Unisuper's standard deviation is 2.23%.

Using Unisuper as the benchmark, the SMSF has a beta of 0.42 and an annualized alpha of 4.75%.* Another way of expressing this is that the SMSF captures 64% of the Unisuper's upside but only 24% of its downside. Reducing downside risk is one of our main goals.

* This is treating the risk free rate as zero. The official CAPM alpha using the RBA cash rate will be a bit lower.

Projected Retirement Income

If we retired today, how much would our retirement income be? To answer the question, I updated an analysis I did a few years ago and came up with this graph:

Passive income is what our combined tax returns would be in each year if we had not received a salary nor made any work related deductions. I also added back charitable deductions and personal concessional superannuation contributions to our SMSF as these aren't costs in the same way that margin interest is, for example. So, it is not 100% passive as it includes realised capital gains and losses. I also plot how much a 4% withdrawal from our superannuation accounts and US retirement fund would amount to under the assumption that we apply the 4% rule to these accounts. My thinking is that unrealised gains on the non-retirement funds would be sufficient to maintain purchasing power. Taxes are likely to be very low, so I just ignore them.

Last tax year our income would have been AUD 154k. Our spending not including mortgage interest and life insurance was AUD 152k. So, this is one reason why I don't feel comfortable retiring as we are spending very close to our sustainable income and spending is likely to continue to rise. On the other hand, if we apply the 4% rule to our entire portfolio at 30 June 2022, it would yield AUD 175k. But maybe the 4% rule is not conservative enough. My recent analysis of how much of our returns is needed to compensate for inflation, was much more pessimistic than this.

If we were forced to stop working we could easily slash spending by taking the children out of private school, which accounts for an expected 30% of our budget.

How Much Investment Income Do We Need to Compensate for Inflation?

 

This chart compares the fitted investment income curve from my previous post about the "boiling point" with the monthly loss of value of our portfolio (including our house) due to inflation. I just took the monthly percentage change in Australia's consumer price index and multiplied by the value of our portfolio that month. The gap between the blue and orange curves is a naive estimate of how much can be spent each month in retirement mode.

Currently, projected investment income is only just enough to cover the loss from inflation. Smoothing inflation over twelve months tells a similar story:

Here I divide the CPI by its value twelve months earlier, take the twelfth root and subtract one before multiplying by the value of the portfolio. This shows that inflation is coming down a little but is still high. We really need to boost our rate of return relative to inflation in order to retire and maintain the real value of the portfolio. It is hard to think about retiring until in inflation is more under control.

Investment income accounts for superannuation taxes, but assumes that the only tax on investments outside superannuation is exactly equal to the franking credits paid.* In retirement, the superannuation tax would go away, but there would be capital gains and other taxes on investments outside superannuation. So, probably it is in the ballpark.

* This is because the series is computed as the change in net worth minus saving and inheritances. Saving is computed after tax including superannuation contribution taxes and income tax.

Superannuation Returns in the Long-Run

Following up from my post on how our SMSF is performing compared to our managed superannuation funds, here is how our superannuation in general has done over time:

Note that the y-axis is a log scale! Our superannuation has outperformed the MSCI index in AUD terms in the long-run. The big win was in the couple of years after 2002 when I rolled over my Unisuper fund to Colonial First State and invested in geared funds. Then I got too conservative leading up to the GFC - the flat top you can see on the red line. Superannuation returns crashed in the GFC because I got aggressive again too early. After that, we have followed the market more closely until after 2018 when we have gone into a bit more of a capital preservation mode again. This reduced the volatility in 2022 but returns in 2023 are a bit disappointing so far.

On the other hand, our non-superannuation assets had catastrophic performance up to 2009. After that, I got my act together, which eventually gave me the confidence to set up an SMSF. But you can see the value of handing control to an external manager early on.

Superannuation returns are pre-tax but after fees. My method of imputing tax paid for public superannuation funds probably exaggerates their performance a bit. These time based returns are quite different from dollar based returns. All the early volatility wasn't that important because total assets were small. Performing well now is much more important.

Enough Wealth followed up on my original post by comparing his SMSF over a longer period to a basket of industry funds.