Understanding Superannuation Will Change How You See Markets

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The first tweet read:

Massive financial collapse, bursting of..bubble..exodus of..companies and large-scale bankruptcies all loom..if..epidemic cannot be contained soon. In short, nothing less than…major economic meltdown.

Coronavirus threatens meltdown in China’s economy.

Then someone replied:

And the CCP (Chinese Communist Party) will just let this happen…come on.

This exchange seems to encapsulate the market’s thinking towards the current coronavirus crisis.

Or any threatening crisis really.

This mentality that the government will ride to the rescue if things get worse. To be fair it’s an attitude the government encourages.

It’s a bluff to try and get people to keep investing and spending, in the hope that it turns out to be the required stimulus for the economy, not the implied intervention.

But with regards to the coronavirus, you’d think there must be some flow through to the general economy over the next few months.

I mean, even my mother-in-law who imports wigs from China received an email from her supplier saying her orders were going to be severely delayed.

If it’s hitting small businesses like that, extrapolate that out a wee bit and think how many links in the supply chain will be hit.

And yet…

Last week markets hit all-time highs.

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Which seems to suggest investors are still thinking beyond any immediate effects and into the ‘stimulation to come’.

Or are they?

I’ve a third option for you today.

It’s actually a strange and often overlooked dynamic that explains why markets move the way they do.

The implications for your investing are huge.

Let me show you what I mean…

This makes shares go up

The headline in the AFR from yesterday read:

‘Cashed up super funds hunt for buying opportunities’

The gist of the article said super funds were sitting on huge piles of cash. And they’d see any market dip caused by a coronavirus panic as a buying opportunity.

Which at face value sounds like they’re not too worried about the economy.

But this type of article feeds into a misconception I’ve found a lot of people have about super. And it’s a misconception super funds are happy to go along with.

They’re happy to invest on any dips not because they’re being shrewd Warren Buffett-type investors…

No, these people simply have no other choice.

You see, super funds don’t actually have that much control of where they’re going to invest your money.

They’re not ‘playing the market’, entering and exiting stocks like some caffeine-fuelled day trader.

What they do is a bit more mundane.

They’re mostly just collecting your money and putting it into the market in the proportions you told them to.

I’ll repeat that…you tell them where to invest.

It’s the choice you make when you select your ‘investment option’ on your super fund. A lot of people can’t even remember what choice they made.

And there’s not much difference between super funds either.

The truth is most super funds are the same as each other.

They invest in the same blue chip companies, using a formula that tries to keep them close to the index performance.

The biggest contributor to your returns isn’t actually performance, it’s fees!

A recent study from Stockspot found that the top 10 funds across different types of investment all had one thing in common — lower fees.

But the point is, the misconception that your super fund manager is sitting there deliberating over whether to go to cash or put more in shares is just plain wrong.

If you’re in the ‘balanced’ investment option — which most people are because it’s the default choice — then you’ve around 70% of your money in the stock market.

Now here’s the thing…

If you’re receiving super every month from your employer as part of the superannuation guarantee (SG) — which is set at 9.5% of their wage — 70% of that amount has to be invested in equities.

That’s money that is going to be invested in shares no matter what.

The super fund has no discretion on that. They can’t decide to put it in cash because they’re worried about the economy, or coronavirus or anything else.

No, they have to invest it as per the investment option you’ve selected.

I think this is a super important point for you to understand.

And when you realise that applies across the entire super industry, you understand there’s money coming into super every month that is going to find its way into the stock market no matter what.

This provides a natural source of demand for shares in all circumstances.

A reversal point on the horizon?

Now, if you’re smart you might’ve realised that money doesn’t just go into super, it also comes out.

And this fact throws up a very interesting future scenario…

You see, when you retire you take money out of super. It’s known as the pension phase.

There are minimums you have to take out, usually starting at 4% of your balance per year and increasing as you get older.

Just like the SG forces money into markets, compulsory withdrawals might eventually do the opposite.

We’re not at that point yet though…

At the moment, more money is still flowing into super than is coming out. By the end of the September quarter, net contribution flows were $38.6 billion for the year.

But that dynamic can and will change.

You see, this year we’ll reach the tipping point where around half the baby boomer generation will be at retirement age.

Then every year after that, more and more baby boomers will be retiring and living off their super nest eggs.

At some point we might get a reversal of the superannuation fund flow. From forced buyers to forced sellers.

What will that do to share markets?

Watch These 10 Aussie Mining Stocks Go NUTS in 2019 (No.8 Is A Ripper!)

A quick last thought…

What if there is indeed an economic collapse sometime in the next year or two? And this group of recent retirees all make the rational decision to get out of the stock market en masse?

I saw this happening in the 2007/08 GFC as a financial advisor and it wasn’t pretty.

With so many more retirees this time around, the next bust could be epic…

Good investing,

Ryan Dinse,
Editor, Money Morning

About Ryan Dinse

Ryan Dinse is an Editor at Money Morning.

He has worked in finance and investing for the past two decades as a financial planner, senior credit analyst, equity trader and fintech entrepreneur.

With an academic background in economics, he believes that the key to making good investments is investing appropriately…

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