Today’s AFR contains an interesting article on housing affordability and a new front on the crisis. It addresses the emerging issue of retirees draining their superannuation savings to pay off their mortgages and then go on the aged pension. Effectively defeating the purpose of superannuation.
But in my view, the article fails to highlight the root cause of this.
Ten years ago I made an emotional decision. I entered the irrational word of the Sydney property market. And what made it especially painful was that I had to sell my beloved share portfolio to fund it.
Since then the asset side of the Mueller family balance sheet has had a healthy ride. This is thanks to a seemingly expensive property market becoming more expensive. There has been much opined about the property market, so I won’t go into it here.
But the liability side of the balance sheet has been a frustrating journey.
This might seem counter-intuitive. Interest rates have generally been on a downward path and, like the majority of mortgage holders, mine was mostly variable. I had mortgage brokers phoning me almost annually to offer me a larger discount to the standard variable rate. And it’s not like my loan to valuation ratio was astronomical.
The reason for my frustration is due a behavioural bias that is forced upon us by legislation.
Mental accounting – a behavioural bias
The bias is known as mental accounting. It is a behavioural bias where people categorise decisions for what is the same economic outcome. These tend to fall into two types, relating to either consumption decisions or payment decisions. Examples best explain them. And I’ll use myself as the culprit to describe the former!
Let’s say the cafe downstairs from Forager’s office increases the price of my beloved mocha from $3.50 to $4.00. “What a rip off,” I’ll think to myself. I’ll walk around the corner and go somewhere else.
But say I’m having a fancy $200 dinner and top it off with a coffee. I won’t even ask how much it is. And, rest assured, it will cost more than $4.
A budget constrained university student opens a bank account to save for a holiday. He or she then opens another account for a car. He or she incurs account keeping fees on both accounts. And he or she earns less as the accounts pay bonus interest as the deposits reach higher thresholds. So the student would be better off combining the two accounts to avoid fees and earn more interest.
But it gets better (or worse for the student). He or she also has a credit card that charges high rates of interest each month. Why not use the funds in the car or holiday account to avoid these high credit card payments? It would certainly result in a better economic outcome.
Like all behavioural biases, it is not an easy thing to avoid. Many people have trouble even identifying it. But it becomes most frustrating when one identifies it but legally can’t avoid it.
Legislation forces mental accounting upon us. We have 9.5% of our salary paid to a super fund and also have personal funds, be they for a deposit account, home loan or credit card.
Going super mental
Here’s the part that irks me. Most of my super is allocated to domestic and global equities. Over the last 10 years, the All Ordinaries Accumulation Index (including dividends) has produced a return of around 3.5% per annum. Global shares have done a little better, returning around 4%, or 5% if currency is counted for. These returns are before fees and taxes and don’t consider the risks of being invested in equities. In the meantime, my superannuation money could have been used to pay down my mortgage for about a 6% post-tax risk-free return.
Our former prime minister, Paul Keating, has a different take on this. Perhaps he is defending his legacy. But I think he misses the point.
Which brings me back to the root cause of the issue identified by the AFR. Those of us whose retirement is decades into the future are usually advised to put our superannuation into riskier assets like equities. This is because the long time horizon is sufficient to ride out the volatility of equity markets.
So superannuation is supposed to provide returns somewhere in line with equity markets. And then we would all be able to retire with a large nest egg. Paying off a mortgage would be a fraction of that nest egg. The problem is that superannuation returns don’t usually keep pace with equity market returns. I’ve addressed the reasons why at length.
And over the past 10 years most super funds certainly haven’t kept pace with the risk free rate for mortgagees. This means that I would have been better off ‘investing’ my superannuation dollars in my mortgage than giving it to most fund managers. But unless legislation changes, I’ll continue to be irked by mental accounting.
24 thoughts on “Going Super Mental”
If everyone could access their super without impacting market prices of realestate then sure, I can see your point. But if everyone was able to access their super then surely realestate prices would go higher and hence you would still lose out?
thank you for this interesting post.
May I ask a question out of interest: Isn’t it the case in Australia that you can put savings into your Superannuation account without paying your normal income taxes ?
So if I am not mistaken, the mortgage repayment has to be financed out of fully taxed income. So shouldn’t one inlcude the Superannuation tax advantage in your calculation ?
Another question: Does this accumulation index include the effects of the “franking credits” on dividends for Austarlian investors ?
As a German, i am highly envious about your superannuation system. We have to save post personal tax and pay high taxes on any capital gains and dividends (without any corporate tax credits) which eat mightily into compounded returns. From the outside, the Australian system (including franking credits on divdends) look highly attractive.
The problem in Germany is that people do hardly own shares and therefore to not participate in the economic development of the country.
From the outrside, Australian shares rather look attractive compared with other markets.
One additional thought: I always find it very ciritcal to use one 10 year period as basis for an analysis. In this case, the 10 year numbers look bad because of the shareprice peak in 2007. If you use the 9 year average, you would get 5,6% p.a., the 8 year average would be 12,1% p.a., the 11 year average 6,0% p.a. and the 12 year average 7,2%.
So by coincidence you seem to have chosen a very unfortunate period for the Australian stock market.
The Australian Accumulation Share Index is based on gross returns so I assume franking credits has been included.
Not all Australian shares provide fully franked dividends. For example, REITs and infrastructure companies do not provide franking credits. Companies that have a large part of their earnings overseas (eg. Computershare, Mac Bank, QBE, Cochlear) may provide partial franking credits. As an overseas resident, you are probably not entitled to franking credits. Worse off, you may be subject to a 30% withholding tax on Australian dividends.
The Australian Share Index is heavily skewed towards the largest companies – dominated by Banking and Materials. We are not as diversified as the Dow Jones Index or S&P 500. If you haven’t noticed, we are far from the pre-GFC peak of 6,800 points. We also lack companies with a deep and wide moats. There’s no Coca-Cola, McDonalds, FANG or Berkshire Hathaway in Australia.
It might be a mistake for you to chase high yield or franking credits for the sake of it. Read up on Phil Carret’s 12 rules for investing. It might be wise to listen to Warren Buffett and invest into high moat companies – at a reasonable price.
You can salary sacrifice some of your pre-tax income into Super but there are limits to this. Refer to https://www.ato.gov.au/super/self-managed-super-funds/contributions-and-rollovers/contribution-caps/. Whilst this may lower your income tax, any pre-tax super contributions pays a 15% tax. Inside super, the super fund pays 15% tax on earnings. With Sydney property prices being so expensive, this is a no go zone for most young – middle age investors with a huge mortgage.
Unlike the US, Australians do not receive a tax deduction on their family home mortgage (only for investment properties). Therefore, mortgage repayments are made from your after-tax income.
Residential home loans in Australia is about 4.5% pa. Can super funds consistently earn this, without risk, after tax? Base on the current high share market valuations and low interest returns on cash within super, it might make sense to use your super to pay off your home loan. This will earn / save you a guaranteed return of 4.5%pa.
Anyone close to retirement or in retirement that has a bit of home loan debt would be foolish not to pay off their debt with super – provided you had some surplus funds left over.
A couple can have AUD $375K in investments / super and still receive the full Age Pension (https://www.humanservices.gov.au/customer/enablers/assets). So with your home paid off, a couple could receive up to AUD $669 pw (https://www.humanservices.gov.au/customer/services/centrelink/age-pension).
The $375K, if invested wisely, could be drawn down by $20K per annum to supplement your Age Pension for the next 20 years. And what would your property be worth over the next 20 years (when you run out of money)? Downsize and repeat!
IMO, I believe our Age Pension is far too generous for those that own their own home. It puts too much pressure on current tax payers. To reduce our income tax, help the Battlers, build affordable housing – we should deduct the Age Pension payments from a person’s home / estate upon death. ATM, tax payers are funding the Age Pensioner’s lifestyle so their kids can inherit their parents’ house / estate (worth up to millions of dollars) WITHOUT paying tax. Totally unfair!
If you have no control over how your super money is invested then you are in the wrong fund. There are industry funds that allow you to choose individual shares.
Also, if everyone suddenly has $30 – $40 k extra with which they can bid for a house then the house price will go up unless you restrict it to those who already have a mortgage which would further exclude first home buyers.
Yes and there are also industry funds that will invest you in a diversified balanced index option (e.g. 75% growth/ 25% defensive) for as little as 0.02% p.a. management fee. Maybe not 10 years ago, but certainly these days with the prominence of index funds, there is no real excuse for not achieving a return in line with equity market indices (well, except for the usual ones like laziness, ignorance, greed, etc).
Can to name a few that charge only 0.02% management fee that allow active management? Healthy brokerage and performance fees on top I presume?
The 0.02% was for an index investment option, as I stated. The reason I mentioned that is the article suggests that super returns don’t keep pace with market equity returns, i.e. index returns, presumably due to fees and most active investors not outperforming (net of fees). There is no brokerage/ performance fee, but there is $78/yr admin fee which is also about as low as it gets in Super (Hostplus balanced index).
I think this article is at least silly if not disingenuous.
Superannuation system is imposed by the government. So, it is like tax. Death and taxes. We just have to pay taxes and eventually we will all die.
The main purpose of superannuation system was to *nudge* Australians to think about retirement funds as *their* money and encourage them to pour more resources into it.
Actually, the Australian superannuation system is much more free and flexible than other similar systems around the world.
In fact, the author of the article has an option of, instead of whinging about it, taking the full responsibility in his own hands by establishing an SMSF and investing his superannuation money in more or less anything he likes including real estate and even gear for it whilst enjoying exceptionally low 15% income tax rate and 10% capital gains tax rate until they drop to 0% in the retirement phase.
I think that Paul Keating had shown exceptional foresight in his design of the superannuation system well before behavioural economics and the ideas of *nudging* people to do the right things became well known.
The one thing that he did not have opportunity to finish though is the saving rate – it should be brought to about 15%.
I agree with mandatory contributions to superannuation as I believe people, in general, will not save for their retirement unless forced to.
As you mention, some may find themselves in the position at retirement of using their super to pay off their mortgage, however without super, I fear these people will find themselves with no super at retirement and still have a substantial mortgage.
I do agree that you should be able to use your super to help with your home mortgage, in particular, using an off-set account to reduce interest on your home loan.
I have a SMSF and most of the time I’m holding somewhere between 10% – 20% in my cash account. Ideally, I would be able to link my SMSF cash account to my home loan as an off-set account to reduce interest on my home loan. A 4.5% tax free return would be a lot better than the 2% taxable return that I currently receive on this cash account.
The best of both worlds, the funds do not leave super but I’m putting the cash to the best possible use.
Obviously one problem with this is the return is incurred outside super in the form of reduced interest and the return in super return actually falls to zero (from a 2% taxable return). This may contravene the rules of super to make investments that will increase in value and to eventually support an income stream in retirement but maybe the interest savings could be contributed into the super fund.
The problem with this article is that the author is selfishly looking at his own situation instead of trying to see the point of view of the entity that established the rules for superannuation. The objective of superannuation is to keep people off of the government pension. If they do not have their mortgage paid off by the time they retire, maybe they should not retire or they should downsize. It seems to me that the author’s solution will lead to a lot of people living in mansions or expensive real estate while claiming the age pension. Looking at your personal situation without considering the social impacts is rather myopic.
I believe Daniel has provided an interesting account about his personal sacrifices (give up his passion for investing in the share market) to buy a home for himself and his family. How is this selfish? It’s common sense. Warren Buffett did it. Buffett could have made billions more had he used the funds to buy Berkshire stock instead of a house.
Daniel had the extreme foresight or was just lucky. He could have used those funds (or in this debate – his super) to buy a house in a mining town. The results would have been catastrophic! Refer to http://www.afr.com/real-estate/property-investors-lose-50pc-in-qld-mining-towns-20160302-gn8qv9 and http://www.perthnow.com.au/news/western-australia/property-values-in-parts-of-was-pilbara-fall-75-per-cent-after-mining-boom/news-story/e10d38fdbc03eb3b85900ddb0ec7c571.
Paul Keating is a smart person. But like most politicians, he’s out of touch with what the average Battler has to go through to buy a home and put food on the table. For example, if a couple in their early 40s had about $400K in super and $200K in savings, why would it be a bad idea to use the $400K super to buy a $1M family home? Or a $600K home near Campbelltown? You’d still have another 20 yrs plus to save and invest for retirement.
Recently, a couple in their early 50s asked me… “Our family home is worth $2M. We have $200K in shares and $5M worth of investment properties. How do we restructure our assets to claim the FULL Age Pension by the age of 65?” Easy and legal!
Your comments, “It seems to me that the author’s solution will lead to a lot of people living in mansions or expensive real estate while claiming the age pension”, is more fact than fiction. Jeez, I know of people who did this legally 20 years ago!
Whilst most Battlers rely on the Age Pension (which I fully support), there are too many home owners and rich people who do not deserve the Age Pension. As mentioned above, I think we should have an Estate Tax or a claw back of the Age Pension from ones’ house/estate. Federal taxes coupled with state taxes/fees/duties in Australia is probably the highest in the developed world and needs to be reduced!
Agree with your comment here and the earlier one Bob. Can’t see much changing though, no politician has the courage or mandate to make any serious changes. If anyone loses out the squealing outweighs any sense of what might be needed for the long-term and to be fair to the next generations. We have been the lucky country for sometime and it might continue too as commodity prices have bounced back again, but there will be a pinch point eventually and something will have to give. Meanwhile income inequality just gets worse and worse. The point was made recently that Super was supposed to be for retirement funding not inter-generational wealth transfer, yet the tax treatment of one’s PPOR and exemption from means testing is clearly having the same distortions but God forbid ever trying to change it !!!!
I used to be fully supportive of super, but I am getting more sceptical. As the recent Commission of Audit noted, even by 2050 — that is, after 60 years of compulsory superannuation — about 80 per cent of retirees will still receive a full or part age pension, the biggest and among the fastest-growing of federal expenses. Trade unions and financial institutions, perhaps the two most powerful vested interests, are in lock step to keep things how they are. The cost of managing Australia’s super assets is on average more than 1 per cent a year — that is, more than $20bn, or more than $1000 a year for every adult in Australia. We may be better off to reconsider if it is wise to force everyone into super.
Great article Daniel and completely agree.
Just wait till you have kids, a mortgage or two, a business, and a SMSF.
A trip to the accountant can be very confusing.
Complex rules and changing complex rules regularly (SMSF) is an administrative burden.
Saving money (through super) at 25 to help you at 70 plus doesn’t look appealing.
You don’t need to have a crystal ball to see that for many younger people Super will be seen as an unfair burden (tax) and it will dwindle as people avoid it to concentrate on other investment vehicles.
SUPER is dead (for youngsters) LONG LIVE whatever comes next.
I have seen it argued on this blog about 1st level and 2nd level thinking. Your argument is majorly flawed because of one point – you assume people will save the equivalent superannuation guarantee and pay it off their house. I very much doubt that many people over their working life would pay ALL of the equivalent super towards their home loan. Besides, our pool of super allows Australia to buy up foreign country assets of which the profits then get repatriated back to Australia which is good for the country as a whole.
I agree with Dennis’ comments very much. Super legislation is about encouraging the right behavior. While people in this discussion may not have this problem, but there’re plenty of people out there if you don’t make them to save for their retirement, they’ll come back decades later with a big debt and no super.
Sara, the problem is lack of money education. Most people get their education from their parents and when the parents are living pay to pay, trying to keep up with the Jones’s it’s n wonder their children don’t know how to save and end up with credit card bills of more than $50,000 (I have seen it ).
I once asked a work colleague how he ended up with a $60,000 credit card bill? What did he spend the money on ? He couldn’t actually tell me except he spent it on “stuff”
In Victoria, the Commonwealth Bank visits primary schools with a person in a furry animal suit called “Cred” and teaches these kids on the benefits of credit cards. What hope do we have?
There is no better teacher than hardship, and in Australia we have a whole generation who have never experienced a recession. When it does finally hit, the frugal will be the ones that survive and benefit.
Hey Daniel, does forager track the number of/length of responses to blog posts? It seems like you touched a hot topic.
Hi Clayton. We can view how many responses each blog post receives but we don’t actively track them. The number of responses to this blog post would be above average. Cheers, Daniel.
Nothing substantive to add to the discussion, just wanted to say the blog is really good.
Each of the different writers is very good at distilling concepts in plain language.
I’m constantly checking for new posts. Keep up the good work.
I think at present that everything written about housing affordability misses the elephant in the room points:
1. Prices rise due to the availability of MONEY.
2. Open markets allow more MONEY from more sources.
3. Housing is still an inflating bubble and giving people more MONEY to pump up the bubble only makes the bubble bigger and the bang even more painful.
Now, MONEY for housing is not money as in rock up with a bag of cash. It’s having enough of a bag of cash to be able to convince a banker that you can service a loan. Then the banker loans you a bag of cash.
Low interest rates = bankers will loan you more, as your income can service a bigger loan. So you can bid up that auction a bit more, or offer a bit more in a sale, etc etc.
First home owners grants, or access to super for use to purchase housing adds more MONEY to the purchasers, allowing them to bid prices up higher (perhaps by not needing to borrow quite as much to still afford what the buyer wants to buy.)
Overseas buyers bring MONEY into the country and add to the pool of buyers competing for the same properties, supply + demand sees a small pool of sellers and a larger than otherwise pool of buyers. Result: higher prices.
It’s called a sellers market for a good reason.
Point #3: Housing is historically and by all measures for Australian history, expensive. A small interest rate rise will cause pain. (HECK: rises of stupidly small amounts like 0.05% cause newspaper headlines. I want to see you young ‘uns paying 17.5% on your home loans. THEN YOU CAN WHINGE!)
Bubbles burst and when that happens there is huge pain and suffering. Prices fall, people lose their houses.
What would it take to bring this on? Perhaps an interest rate rise of 1% – 2%… not much.
The point of all this is that allowing access to MORE MONEY will just make a bad situation worse. Allowing access to super gets floated every fews years and it is a really bad idea.
Super is for retirement.
Allowing borrowing in super funds (thanks Mr Costello) is a really dumb idea.
Allowing super funds to be used for the beneficiaries to purchase ANYTHING AT ALL (including housing, holidays, or a new dishwasher) is a really dumb idea. It pollutes the purpose of super and leads to higher housing prices.
It’s pretty much that simple.
Interesting that not one person has noted the date at which Mr. Mueller commenced the process of reviewing his opportunity cost – close to the ASX record high – only seen since in the accumulation, not price indices. Naughty Daniel.
Daniel, if your super-fund has not performed that well, then you may be in the wrong super fund. Are you in a low fee super fund? There are plenty out there these days. In the longer term (over 10 years) fees do make a noticeable difference to performance.
Why is the student paying bank fees? Do what I did, contact the bank and ask them to waive the monthly fee or you will walk. I now have a deal that as long as I keep $2,000 in my account I have no fees.
If your bank won’t budge then contact NAB, ING or ME bank. Some or all of these may have fee free everyday bank accounts.
Why are you paying credit card fees? Debit cards now have Visa attached, use this instead.
Or set up a paypal account, to pay securely on-line.
Appreciating assets excepted, for all other expenditure, if you need to use credit, it means you should not buy it as you can’t afford it.
Why are you paying $4.00 for a coffee? My brother-in-law bought a $60 coffee machine from Aldi and bought it to work for him and his staff to use. It paid for itself within 2 months and it lasted 6 years before it broke down. Bring your own machine to work and make your own coffee (I am sure Steve will grant approval as long as you allow him to use it).
You you bring your own lunch to work? That saves a lot of money.
Get yourself a 100% mortgage offset account place your salary/dividends in this account. Take as needed, pretty soon your mortgage will drop.
I had a 25 year mortgage and super, and over time built a share portfolio. The mortgage was paid out in 18 years.
Sounds to me “lifestyle choices” are the major reason people want to tap into their super.
A mortgage means sacrifices, and a reduction in lifestyle. That is the only way to get the mortgage monkey off your back quickly.
Suck it up Dan, super should be off limits to everything other than providing an income in retirement.
The only reason you have this mental accounting issue is because Australia has aspired to move towards a fully-funded retirement system, so you can see real dollars piling up in an account. In most of the world, government pension promises are largely unfunded, today’s workers pays today’s retiree, tomorrow’s retirees will be paid by tomorrow’s workers. There’s no substantial pool of capital. Our system, despite its quirks and problems, is far superior. But if people can start accessing their super for other items, it all falls to pieces.