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BusinessDay www.businessday.co.za Thursday 10 February 2022
INSIGHTS
RETIREMENT FUND INVESTMENTS
Balanced portfolio the best defence The last few weeks of January, yet again, were a reminder to investors of just how quickly things can and do change in financial markets, and why a balanced portfolio of assets remains the best defence for long-term investors. “Towards the end of 2021, we were very bullish about South African equities and worried about global equities, given high valuations and elevated levels of exuberance,” says Pieter Koekemoer, head of
Personal Investments at Coronation Fund Managers. “Today, we maintain our view that the local equity market offers meaningful upside to fair value, despite the strong recovery since the onset of the pandemic.” Following the recent selloff in global markets, Koekemoer says Coronation is now also optimistic about the opportunities being presented to stock pickers, given the dramatic declines that have
taken place in some parts of the market. “The correction in global markets is a positive,” he says, adding that long-term investors could do well by ensuring they have healthy levels of exposure to all asset classes, especially the domestic asset classes and global equities. “The exception is global bonds, where we expect returns to be anaemic over the next decade,” he warns. While investors might be
tempted to head for safety in this market environment, now is not the time to be sitting in cash, he says. “We believe that investing in a balanced, well-diversified portfolio of assets remains the most appropriate choice for most long-term investors, allowing skilled professionals to take advantage of these opportunities as and when they are present and rebalance exposure to the different asset classes on behalf of investors.”
How much money is enough to retire? One of the most common questions posed to financial planners is how much money is required for retirement. Travis McClure, a private wealth manager at NFB Private Wealth Management, says his standard answer to this is “as much as possible”. “A simple calculation for how much money you need once you are retired would be 20 times your annual salary or required annual income. So, assuming you need R30,000 per month as your retirement income, you would need 20 x R360,000 which is R7.2m.” This amount would allow the retiree to withdraw an annual income of 5% per
annum off the capital and any excess growth above that would go back into the capital to ensure some growth in income and capital against inflation. What income percentage or withdrawal rate is the right number? “It all depends on your budget,” says McClure. “The ideal number should be between 3%-6% per annum.” This allows for some capital growth over and above the income percentage, he explains. “Most pension or cautious to moderate portfolios target inflation plus 3% to 4%. With average inflation running at about 5% to 6% per annum, this means that should the portfolio return 9% and you draw 4%
there is 5% in capital growth on your pension.” With that, he adds, comes an increase in income each year as the capital grows. However, drawing too high an income can put the capital at risk. “If one starts to draw into capital you can get into a dangerous spiral as the withdrawal rate just increases as the capital depletes. This makes it harder for the capital to recover and you run the risk of running out of capital in your lifetime,” he cautions. Inflation, warns McClure, is a retiree’s biggest risk. “Retirees need to ensure the purchasing power of their money keeps pace with inflation.”
Other risks include market risk, economic risks, health risks and a withdrawal rate risk. How much risk should retirees be prepared to take? “When someone retires, they move from a capital growth phase to an income phase,” explains McClure. “Although the retirement portfolio should become more income based — with a focus on assets that provide more of an income yield and have less volatility like cash, bonds and property — one cannot ignore the need for growth assets.” For retirement capital to keep pace with inflation one should have a portion invested in growth assets, he advises.
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Values shift: staying in touch is critical
Be aware of all •options to protect your financial security, writes Lynette Dicey
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inancial security in retirement matters more than ever and it’s important to be clear on when guaranteed income makes more sense than living annuities. According to the Living Annuities Survey compiled by the Association for Savings and Investment South Africa (Asisa), living annuity policyholders managed to keep the average drawdown rate practically unchanged at about 6.6% pre-pandemic. However, the steep rise in the cost of living in SA could have a big impact on this with many people already drawing the maximum allowed percentage of 17.5%, says Stephan le Roux, a registered financial planning coach at Old Mutual Wealth.
WHAT’S THE DIFFERENCE BETWEEN A 35-YEAR-OLD AND A 65-YEAR-OLD?
Stephan le Roux … volatility. “It’s also important to be aware of the dangers of personal preconceptions of what is required for retirement. Values shift over time and it’s critical to stay in touch not only with the world as it was, but also the world as it is and could be,” he adds. In 2019, research and consulting organisation LIMRA did a study called The Value of Guarantees to establish investors’ views and perceptions around taking the lump sum or the guaranteed income at retirement. This study revealed that 47% would like to convert a portion of their assets into an income. However, as they approach retirement this figure drops to 30%. The study found that more than one-third of pre-retiree and retiree investors want to use a guaranteed income to cover their basic living expenses and nonguaranteed sources to cover the rest. Added to this, context and framing are critical in assessing how many people would like a guaranteed income: a hypothetical choice between a guaranteed income and a lump sum (as opposed to parting with own assets to generate an income) led to 52% of pre-retirees and retirees choosing the guarantee. “The preference for a guaranteed income is driven by an expectation of living longer and a desire for peace of mind,” explains Le Roux, adding that
those who choose the lump sum do so mainly because they want control of their money. The study revealed that the core emotional value of guaranteed income is “peace of mind”. Other factors are protection during cognitive decline, ability to take more risks with other lump sums and improved retirement lifestyles. It also found – perhaps not surprisingly – that those with a preference for guarantees tend to have less wealth and financial sophistication. Generation X and Millennials, in particular, prefer guaranteed incomes. Flexible income is one of the main reasons why living annuities are so popular. “Investors want to feel in control of their annual drawdown percentages,” he says. “Another consideration is flexible investment options, particularly if bequests need to be made. In this case there is a bigger responsibility to manage behaviour and expectations.” What about the risks? “Sequence-of-return risk becomes a danger when withdrawals are made from a fund’s underlying investments,” says Le Roux, explaining that the order or the sequence of annual investment returns is a primary concern for retirees living off the capital of their investments. “Negative returns in the early years of a living annuity investment will have a drastic effect on capital. This may result in the capital being depleted a lot sooner than if those negative returns arose later on, leaving no capital to draw from.” Research shows that portfolio volatility, often treated as substantially less important than investment returns, matters a lot for living annuity investors. “In fact, higher portfolio volatility in an incomeproducing portfolio acts as a drain on portfolio performance. Conversely, lower volatility seems to ‘create’ additional returns for an incomeproducing portfolio because it helps the portfolio manage
sequence-of-return risk more effectively,” explains Le Roux. When choosing a living annuity, he advises, select a portfolio that targets real growth with low volatility to ensure you are optimally positioned for success despite what might happen in the markets. For drawdowns exceeding 4% per annum, a living annuity investment strategy should aim for at least 60% exposure to equities, he says. “Returns have an impact: for every 1% additional real return, about 0.9% per annum of additional sustainable income is generated. About 0.1% of sustainable income seems to get lost through time value of money and the fact that incomes are reviewed only once a year,” says Le Roux. Volatility also has an impact. “For every 1% reduction in the level of volatility, an additional 0.3% per annum of income could be taken,” he says, revealing that volatility can be managed through active asset allocation, manager selection and smoothing portfolio returns. The six steps which provide peace of mind in retirement, says Le Roux, are to make use of guaranteed annuities for haveto-haves; use living annuities for nice-to-haves and long-term emergencies; use discretionary investments for short-term expenses and emergencies; ensure enough growth; minimise volatility; and use dynamic withdrawal strategies. “When it comes to retirement the basic guidelines are not to increase withdrawals and to defer ad-hoc expenses after a negative year and only give a 10% real ‘raise’ if capital reaches 150% of the initial investment. Understanding and distinguishing between needs and goals is key to a successful outcome in retirement. Ultimately, it’s important to understand all your retirement options before committing to a solution so you are optimally positioned despite what might happen in the markets.”
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