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Either/or thinking dangerous
Either/or thinking is very dangerous when it comes to retirement income, a financial economist believes.
Breaking the either/or thinking for having either stocks or bonds in a portfolio, or having a risk on or risk off portfolio is important, according to director of Drew Walk & Co, and co-author of a Challenger commissioned report on equity risk premium, Michael Drew.
The report found the popular thinking that equities will always outperform in the long term is not true.
Challenger's chairman for retirement income, Jeremy Cooper, said a long time does not necessarily diversify the risk you take by investing in equities.
"Your average annual return averages out your reversion to the mean, but your actual outcome can vary considerably," Cooper said.
"The premium that you get investing in equities is volatile even over a 20-year period. A long time in equity markets does not diversify the end-to-end risk. It might make the annual returns look closer to what you expect but you can still be a long way from where you want to be at the end.
"You do need equities in retirement but you can't set and forget. You can't rely on historical averages as being a sure bet."
Drew said the findings meant that timeframes and horizons were important and so were breaking the either/or thought.
"You need to have more both/and, and/and discussions on portfolio designs to match the retirement income horizon, and the sort of risk retirees are able and willing to bear," Drew said.
"We're living longer so I think part of the answer is the understanding of the unpredictability of the equity risk premium and how we might think about that in the context of the core retirement income liabilities we are trying to meet."
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