Brent Sheather: Next decade looks a toughie all round

The biggest variable of all is the savings calculator you use to forecast your savings. File photo / NZH

Two weeks ago, we looked at the long-term forecast returns from international shares and bonds from the authors of the Global Investment Yearbook (GIRY) and the analysts at Barclays Capital who publish the annual Equity Gilt Study (EGS). Both of these groups of experts reckon we are in for lean times in the next 10 years with the EGS forecasting returns of just 3 per cent a year for international bonds and both groups estimating returns of about 6 per cent a year for international shares.

For mum and dad investors in Auckland with their funds managed by the typical financial adviser with all-up annual fees and charges of 2-3 per cent a year, we can estimate the after-tax, after-fee, after-inflation return from international shares and bonds as -0.65 per cent and -1 per cent respectively.

These forecast negative returns for international bonds and shares are particularly significant for KiwiSavers, contributors to superannuation funds and investors generally because the average savings plan has about 50 per cent in shares, two-thirds of which are in international shares. A further 20 per cent of the average portfolio is in international bonds.

Using this data and assuming 6 per cent nominal returns on New Zealand bonds and a generous 9 per cent a year for New Zealand and Australian shares, we can calculate forecast returns for a balanced portfolio for the next 10 years. We can then compare this number with the assumptions various local savings websites are using.

With the average portfolio managed by a financial adviser/stockbroker invested 40 per cent in bonds and 60 per cent in property/shares, and incurring annual fees of 2-3 per cent a year, the after-tax, after-fee, after-inflation return, assuming all of the above, is an underwhelming 0.4 per cent a year. KiwiSaver investors generally enjoy much lower fee structures so, assuming a 1 per cent total annual fee including transaction costs, and incorporating the low overseas bond and equity return forecast, we get to an after-tax, after-fee, after-inflation return of 1.7 per cent a year.

To put these numbers in perspective, the actual real return of a balanced portfolio in the 10 years ended February 28, 2011, before tax and fees, was just 1.2 per cent a year. Take off tax and fees and the after-tax, after-fee real return is likely to have been negative, unless your fund manager was particularly astute or just lucky.

Remember, however, that forecasts of future returns are just that, forecasts, but the views of these experts over the longer term are likely to be better than most and what they scream out is that returns from bonds and equities will be low in the next 10 years at least.

In 10 years' time, however, if Barclays is right, the yield on US 10-year bonds will be 7 per cent so that returns from bonds will progressively get better as yields rise, for new investors. So perhaps the one concrete lesson that we can take away from all this depressing research is that, in a low-return world, high fees of 2-3 per cent a year are unsustainable.

If you can't find somebody who can put together a savings plan with maximum annual fees of 0.5 per cent a year you may be better off leaving the money in the bank.

Now let's take a look at some of the local investment calculators to see if they need to be re-programmed. Choosing how you will save for retirement has probably never been more difficult. There are so many choices: KiwiSaver, company superannuation, private superannuation, DIY investing, buying a house - and that's just the start. Then there is the matter of asset allocation: how much in bonds, property and shares. All these variables will impact the terminal sum you save before stopping work for good.

The biggest variable of all, however, is the savings calculator you use to forecast your savings.

Pick the right one and you could be thousands of dollars better off come retirement day. Make the wrong choice and you may still be working when you are 70.

How realistic are these calculators? Armed with the conservative forecast for global bonds and global equities we covered two weeks ago, thanks to the Global Investment Returns Yearbook and the Equity Gilt Study, we can take a critical look at some of them.

New Zealand's financial institutions have a chequered history when it comes to forecasting how soon you will get rich using their products.

In the past, some have even conveniently forgotten fees, tax and inflation.

A computer model is supposed to be an "abstraction of reality". But fees, tax and inflation have a probability of close to 100 per cent.

In the past decade, a number of negative factors have affected prospective returns. For a start, interest rates are much lower, the inequitable fair dividend rate of tax has been forced upon us, share prices are higher, forecasts of economic growth are lower and the impact of demographic change (more older people who tend to liquidate savings and fewer middle-aged people who tend to save) will become increasingly evident.

The table above sets out the after-inflation, after-fee, after-tax returns used in savings calculators by various companies and the Retirement Commission for a long-term savings plan with a balanced portfolio.

The range of forecast returns is wide: from $52,000 for a calculator incorporating the assumptions of the GIRY/EGS to the $123,900 forecast by a stockbroking firm. The average is for a terminal sum of $76,500.

In fairness the stockbroking firm does note that the return was pre-fees, tax and inflation, but the bottom line is that the calculator forecasts $123,900, with a graph illustrating the fact suggesting that it was achievable.

Local regulatory authorities might like to consider whether this freedom to choose growth rates is appropriate as, in 2003, the Financial Services Authority in the UK decided intermediaries can't be trusted to be responsible and then dictated what rates of growth were appropriate.

What should New Zealand investors do? The independent experts seem to think that, at least in the next 10 years, returns will be 1-2 per cent a year rather than the 2.5-9.5 per cent used here. David Kneebone, of the Retirement Commission, said he had spoken to the commission's actuaries, Melville Jessup Weaver, and it was comfortable with its forecast.

A good rule of thumb for private investors might be, however, to assume that the higher the growth forecast used by the calculator provider, the higher the annual fee is likely to be.

Brent Sheather is an Auckland-based authorised financial adviser and his adviser/disclosure statement is available on request and free of charge.