Q. My wife and I are retired and hold substantial investments in a large Queensland superannuation fund.  During the GFC, we shifted from the Balanced Option to the Diversified Bonds Option.

We understood, perhaps simplistically, that the return from Bonds should generally increase as the Cash rate decreases. However, that does not appear to be holding true at the moment.  Should we simply hang on and tough it out?

Having been bitten once, we don’t wish to return to equities, despite the long term evidence of their value.  I don’t have a lifetime in front of me to ride out the peaks and troughs of the stock market.

Thanks for any advice or support you may be able to provide.

A.  There are a number of steps you should take to reduce likelihood of making a bad call.

Clearly understand what your appetite for risk is.  By determining your risk profile, you will have an understanding of what asset classes you should be invested for the long term.  Your Super fund may have a profile tool on their website to assist you in this process.  You should aim to be invested in accordance with your long term risk profile.  Most retirees look to have around 40% of their assets invested defensively.

Having shares or volatile assets in your portfolio is important to provide growth in the long term.  The critical thing is to construct a portfolio to ensure that you are not forced to sell these assets to provide for your income needs at a loss during a downturn.

Identify the income you require to draw from your Allocated Pensions over the next 2 years and hold this amount in cash and term deposits within the Allocated Pension.  Draw your income payments from these funds.  When markets improve, top up the cash account from growth assets.

Bond funds generally invest in a range of Government and Corporate Bonds with varied coupons (interest rates), duration (time to maturity) and quality (Credit Rating).  The bond manager will actively trade the portfolio to reduce capital volatility and income volatility.  You are correct that if interest rates fall, the capital value of bonds should rise.  This is the case if new issues of bonds have a lesser coupon or the quality of the existing bonds in the portfolio is sustainable i.e investors believe the bonds will be repaid on maturity!  During the GFC, there has been no certainty of this.  When interest rates start rising at some stage in the future, the reverse will also be true; the capital value of bonds will fall and investors will see equities like volatility in their returns.

Share markets have rallied since 1 July and the average Balanced fund will have performed around 5-6% Financial ytd.  By comparison a diversified Bond fund would have performed around 3-4% over the same time period and cash around 0.8%.

From time to time you may wish to reduce exposure to growth assets if markets are overvalued, but if you fully divest out of growth assets you run the risk of missing the market getting back in.

This article was originally published in The Australian