It might be useful to think of saving for your retirement like planning a forty-year journey on a yacht, across wild and unpredictable oceans.
It will be a long journey and weather conditions are likely to range between periods of storms interspersed with periods with no wind, so it would be worth your while to take two or three boats in case of damage to any of your fleet. You will need to find qualified skippers for each boat and understand your navigational instruments to make sure you are on track.
Having arrived at your destination at the age of 65, your journey will not be over. The ‘cargo’ carried in your ship, your retirement savings, will have to be enough to take care of you and your family until you die. With medical innovations and improved diagnostic capacity, this could be a period of 35 years. Your ‘second target’ is therefor to get to the end of your journey with enough money to live on.
1. Give yourself a decent amount of time to reach your destination and set reasonable targets for your journey
This point does not need further explanation. It is logical that someone who starts saving for retirement on Day One of their first job stands a better chance of saving more money than someone who starts saving on the day they turn 40. The later you leave your Day One, the higher the percentage of your income you will have to save to reach your target, and the higher the investment risk you will be forced to take.
A reasonable target to launch your retirement journey is to choose a combination of funds and investment strategies designed to generate performances that beat inflation by between 2% and 4% a year on average, over the duration of the investment.
2. Maximise your chances of making your target
The only guide we have to the future performance of funds is the past investing environment. And the past tells us that over the course of time different socio/economic/political factors drive the value of equities, property and interest-generating assets in a series of cycles.
Selecting a range of asset types: The South African Pension Funds Act prescribes the choice and weighting of assets invested in retirement funds. Investment rules are laid out in Regulation 28 of the Act and provide for portfolios that should have a weighting of no more than 75% in equities. The main purpose is to protect the members’ retirement provision from the effects of poorly-diversified investment portfolios.
Investing across a range of geographies: At Rosebank Wealth Group we encourage our clients to take full advantage of opportunities to invest offshore. Diversifying an investment portfolio can help reduce the political and investment risk associated with any single geographic zone. In the February 2018 budget, Finance Minister Malusi Gigaba announced that the offshore investment allowance for institutional retirement funds would be increased from 25% to 30%. At the same time, the allowance for investments into the rest of Africa would also increase by 5% to 10%.
Investing across a range of investment styles and strategies: There are no all-weather fund managers. By this we mean that there are no single fund managers that dominate the award ceremonies using the same investment style year after year. We know that different fund management styles generate different returns at different stages of the investment cycle. A value fund manager might have her day in the sun for a few years or months, and then the investing environment will change and the ‘growth at a reasonable price’ fund managers will win all the awards, followed perhaps, by index funds dominating the performance boards.
When you select a fund manager you are not buying performance, you are buying a predictable style of managing money.
Investors have to understand why their managers are underperforming as the cycle changes, and be comfortable with this underperformance, knowing that it will revert in due course. Understanding the drivers of performance of sectors and asset types is key to a multi-decade investment strategy.
Investing across a range of asset management companies: Your financial advisor will help you choose a range of asset management companies that can be counted on to think differently about the investment process. This will ensure that your investment returns are not unduly affected by ‘single idea investment risk’ that could come about if your portfolio is in the hands of a single manager.
3. Don’t give up half way
It goes without saying that you should not give up on your journey half way (sell your investments) and that you should allow the equity portion to compound in value. Your overall target of real performance of between 2% and 4% includes good years and bad years and should be oblivious of ‘other boats’ in the race.
Sometimes it is disheartening to look back and see how little your investments have returned. A look at recent returns of Regulation 28-compliant unit trusts over three-, five- and ten-year periods does not make for cheerful reading.
Average fund performance over 3, 5, 10 and 15 years relative to CPI, Annualised (%)
|3 years||5 years||10 years||15 years|
Source: Profile Media May 18 2018
Over three years, the average fund performance of the multi-asset high category of unit trusts, and the multi-asset medium category (two of the unit trust categories permitted to invest money in pension assets in accordance with Regulation 28 of the Pension Fund Act), under-performed inflation.
Over ten years, there is a 31-basis point differential between the performance of the average multi-asset income funds and the average performance of the multi-asset high category. Only when measured over 15 years do those funds, mandated to allocate a higher percentage of assets to equites, reward investors for taking more risk and significantly beat inflation.
Bear in mind that the measure of inflation, CPI, is the average consumption of goods and that people in different income categories can have an actual CPI much higher than that measured by CPI. For example the current year-on-year inflation rate is 3.8%, but the categories ‘health including insurance’ is 7.9% and ‘water and other services’ is 6.8%. People who own their own houses and those who are members of medical schemes would therefore have a relatively higher ‘personal’ CPI.
4. Check in with your progress
In the past it was difficult for investors to keep track of the success of their individual investment goals and calculate the extent to which they were on track or not. Comparing your fund performance with another would not provide any insight, as the timeline of your investment versus the other could be completely different. Analysing your savings to date would be meaningless unless other factors such as living expenses during retirement were also factored in.
However as of 2018, several financial advice companies have access to software programmes designed to show clients the combined value of their assets, how much they have saved and how much they still need in order to retire comfortably. The assumptions that form the base of these illustrative returns, such as inflation, salary increases, and performance of investments, can be adjusted to actual figures so that clients can easily see whether they are on track to meet their goals or not.
These systems can provide an estimate for the capital required to generate a pension in today’s values of say R20 000 per month. In addition, ‘windfall gains’ such as an inheritance or misfortunes such as retrenchment can be factored in, giving investors a real dashboard/or bird’s eye view of their progress.
5. Dealing with headwinds
So when is it too soon to panic? We don’t think panicking is ever in order. And the most we would ever recommend by way of an adjustment to a portfolio would be a small tweak. We will deal with this in the next article.