Whichever retirement plan type you are invested in – pension fund, provident fund or manager’s insurance- there are options regarding the level of risk ranging from conservative to aggressive you can choose.
The level of risk is typically defined as the percentage invested in equities. Investment in equities is risky, and according to the studies there is a direct link between risk and return such that the greater the risk taken on the higher the return. Traditionally the equity allocation depends on the age of the saver with younger savers choosing higher equity allocations and lowering as retirement age approaches.
It is important to understand that the higher average returns for equity market investing is only true for the very long term. Below are the historic returns for 3 common asset allocations (Source Vanguard).
| 1926-2014 | 2000-2014 | |
| 80% Bonds/20% Equity | 6.7% | 5.7% |
| 40% Bonds/60% Equity | 8.7% | 5.4% |
| 20% Bonds/80% Equity | 9.5% | 5.1% |
The second column of the table shows bedrock of asset allocation, equity investment over the very long term 1926-2014, albeit risky, provides for a higher average annual return. However when examining the 15-year period from 2000-2014, we see the opposite is true!
In practice, in Israel most savings are invested at medium risk in a “one size fits all” strategy in effect the average for all ages. This means that this strategy is good for the average but does not really fit anyone at the individual level. The effects of this was most pronounced in 2008, when many savers approaching retirement saw their lifetime retirement savings drop by 10% or more.
Selecting the best options for a retirement portfolio is important and the average is not good for everyone. Equity market investment is volatile and the personal circumstances of the saver including age, financial profile, and risk tolerance need to be taken into account. But more importantly understanding the true picture of the asset allocation behind the “average” and whether it is appropriate for the individual saver is vital.