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Tackling loss aversion with Milliman

Written by Milliman

Most people wouldn’t choose to set up a financial planning business during the global financial crisis. But financial planner Derek Fitzgerald lives the advice he gives clients: it’s time in the market, not timing the market.


“For most people working in financial planning nowadays, the GFC is your worst case scenario,” Fitzgerald, who works at Power2 in Mackay, Queensland, says. “That's what we always reference back to with our advice and model for clients: if another GFC hits tomorrow, this is how you would fare.”


The GFC, which struck in late-2007, halved the value of many major equity markets including the S&P/ASX 200. Even diversified funds weren’t spared. The median superannuation balanced option fell 18.5% over the six-month period between September 2008 to February 2009, according to SuperRatings.


Fitzgerald says it has a major impact on the psyche of investors.


“No one ever complains about getting 8% when they could have got 10%, but they certainly complain about getting negative 10% when a more conservative approach would have lost them a lot less,” he says. “So the upside and downside feelings for clients don't follow a linear relationship.”


This is loss aversion: the way average people feel the pain of losses far more than the pleasure of gains. Older investors who have reached their maximum savings and so have little leeway to weather a market downturn, are particularly loss averse.


But even some younger investors are prone to loss aversion. The ASX Australian Investor Study 2017, which surveyed 4,000 Australian residents, found that four in five young investors (81%) wanted guaranteed or stable investment returns.


A 2007 US study of older investors revealed a more typical result: it found that half of retirees were unwilling to take a 50% chance of losing as little as $10 in exchange for a 50% chance of winning $100. Clearly, the fear of losses hurts more than the pleasure of gains.


Fitzgerald says the majority of his clients are also approaching retirement.


“The biggest questions are: when can I retire, how much can I spend, and when am I going to run out of money? A big part of our businesses is ascertaining the answers to those questions, and if the answer is not great, trying to put strategies in place to make those answers a little bit more comforting.”


The answers are not simple, and making it more complex, older investors are often flooded with complex and contradictory information about retirement. Fitzgerald says a lot of the time, clients are worried that they will “lose it all”.


“Statistically, that’s very unlikely unless you have a lot of debt involved. We try to bring that conversation back to ‘you're not going to lose it all but what if it the stock market halves like it did in the GFC?’


“There are two answers to that. One is an asset allocation decision: how much risk to take on? The other is how much risk do we take on within the equity exposure itself – this is where the Milliman strategy comes into play.”


Milliman’s risk overlay allows investors to retain the benefits of potentially higher growth from equities while dampening volatility and providing some protection against capital losses.


The overlay uses exchange-traded futures, which are traded following a rules-based system in direct response to market conditions. When market conditions are more volatile, the level of protection rises, and when markets are benign, the level of protection is removed.


This also has the added benefit of helping investors stay the course when market conditions deteriorate. Many investors eventually succumb to poor market conditions and the accompanying media headlines, withdrawing their investments at the worst possible time.


That type of investor behaviour – poor market timing – is largely the reason why the average US investor’s mutual fund return trailed the average mutual fund by an annualized 137 basis points over the past 10 years (5.53% versus 6.90%), according to a recent Morningstar report.1


“While the Milliman products in a rising market will give you a lesser return than the naked stock market will, just because of the additional cost there, it's still significantly better than cash and term deposits,” Fitzgerald says.


“We figure that giving up 0.5% or 1% on the upswing in the market is a small price to pay for keeping clients invested throughout the full duration of the market.”

This document has been prepared by Milliman Pty Ltd ABN 51 093 828 418 AFSL 340679 (Milliman AU) for provision to Australian financial services (AFS) licensees and their representatives, [and for other persons who are wholesale clients under section 761G of the Corporations Act].

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Unless otherwise specified, this document has been prepared by Colonial First State Investments Limited ABN 98 002 348 352, AFS Licence 232468 (Colonial First State) based on its understanding of current regulatory requirements and laws as at the date of publication. While all care has been taken in the preparation of this document (using sources believed to be reliable and accurate), to the maximum extent permitted by law, no person including Colonial First State or any member of the Commonwealth Bank group of companies, accepts responsibility for any loss suffered by any person arising from reliance on this information. Colonial First State is the issuer of interests in FirstChoice Personal Super, FirstChoice Wholesale Personal Super, FirstChoice Pension, FirstChoice Wholesale Pension, FirstChoice Employer Super offered from the Colonial First State FirstChoice Superannuation Trust ABN 26 458 298 557. It also issues interests in the Rollover & Superannuation Fund (ROSCO) and Personal Pension Plan (PPP) offered from the Colonial First State Rollover & Superannuation Fund ABN 88 854 638 840. Colonial First State also issues other investment products made available under FirstChoice Investments and FirstChoice Wholesale Investments, other than FirstRate Saver, FirstRate Term Deposits and FirstRate Investment Deposits which are products of the Commonwealth Bank of Australia ABN 48 123 123 124, AFS Licence 234945 (the Bank). Colonial First State is a wholly owned subsidiary of the Bank. The Bank and its subsidiaries do not guarantee the performance of FirstChoice products or the repayment of capital from any investments. This document provides information for the adviser only and is not to be handed on to any investor. It does not take into account any person’s individual objectives, financial situation or needs. You should read the relevant Product Disclosure Statement (PDS) before making any recommendations to a client. Clients should read the PDS before making an investment decision and consider talking to a financial adviser. PDSs can be obtained from or by calling us on 13 18 36.


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