NOMPU SIZIBA: If you’re a pensioner or you’re about to get there, you need to consider whether your retirement fund will be properly invested to grow the capital to its maximum potential, given that these days people can live so much longer. To share some tips on how this can be done I am joined on the line by Jaco van Tonder, he’s the advisor services director at Investec Asset Management. Thanks very much for joining us, Jaco. Before we get into the main discussion please just explain to us about how living annuities work and are they the only vehicle in town to provide a pensioner with an income, or are there alternatives?
JACO VAN TONDER: Your last question – broadly speaking, there are two types of options any prospective pensioner can consider to invest their retirement fund assets in order to produce an income.
The one class of product I will refer to for simplicity is guaranteed annuities and those are typically provided by a life insurance company, and your payment for the rest of your life is guaranteed by the insurance company. Your capital, however, is taken up by the insurance company – you generally can’t get access to it, but at least all your benefits are guaranteed and your investment risk and your longevity risk is essentially ensured. So that’s the one class of product.
The second class of product is the living annuity and the living annuity is essentially the exact opposite of a guaranteed life annuity, so there are no guarantees – your longevity risk and your investment risk is borne by the pensioner themselves. You invest the money like you would any other pot of assets and, on a monthly basis, you can withdraw an income from that pot of assets – but clearly you need to manage the pot and you need to manage the income that you draw to ensure that there’s enough money left to last you the 30 years that you are likely to live from age 60 to age 90, and therein lies the challenge.
NOMPU SIZIBA: The law hasn’t yet kicked in where all pensioners will get a third of their cash and they then have to invest the rest. Some people still get the full pot of their pension when they retire. How important is it that they don’t delay putting those funds in an investment pool to help them secure a long-term income?
JACO VAN TONDER: Time in the market is what long-term investments are about, so I would suggest that irrespective of whether someone cashes in their pension pot, as we colloquially call it, or they transfer their pension pot into a living annuity, I would suggest that people as soon as possible invest those monies in an appropriate portfolio to ensure that you are correctly positioned – because it doesn’t really matter whether you’re saving your living annuity for your future income or you’re saving outside because you’ve cashed in your pot. There are particular aspects to the portfolio. You’ve got to have enough shares, for example, and we’ll probably talk about that a bit more but you need to have enough growth assets to ensure that the pot of assets keeps pace with inflation and allows you to not only draw an income in future but also every year broadly increase that income with inflation so that you can preserve the buying power of your income over the 30-year expected lifetime.
The ‘new normal’ of retirement investing
NOMPU SIZIBA: Now, touching on what you’ve just said, traditionally you say that living annuity funds have tended to be invested in fixed income assets like bonds in a bid to beat inflation, but you’re suggesting that there now needs to be a new normal in terms of where those funds are invested. Just elaborate, if you will.
JACO VAN TONDER: Clearly the investment strategy followed in a living annuity is the decision of the pensioner in consultation with the financial advisor. In most cases today, that would be the norm. So if we look, for example, at our book of living annuities at Investec, and we look at what people invest in, on average we find that living annuity portfolios have roughly around 30% to 40% exposure to equities and the other 60% to 70% of the portfolio would be invested, as you said, in some range of fixed income fund.
What we have found in some of the modelling and some of the research work that we’ve done over the past year on appropriate living annuity portfolios is essentially that that level of equity exposure is not high enough for people who are drawing higher incomes. So what we found in our book, let’s say, about 40% of the portfolio in equities is really only an ideal strategy for income levels of about 3%, 3.5% and maybe 4%. That’s it. If you are drawing an income in your living annuity of 4.5% or 5% or 6%, for example, and you still have 30 years left to live, you need to up your exposure to equities quite dramatically from the 40% number that many people have today, to roughly 65% or even 70%.
NOMPU SIZIBA: That’s quite hectic. If you speak to a financial advisor, they’ll advise you about the possibilities of capital growth if you invest your money here or there but there’s always that caveat that equities investments can go pear-shaped. Imagine if part of someone’s pension was recently invested in Aspen, for example, or EOH, Resilient or Steinhoff – so how does one address fears around these live examples where significant value has been lost?
JACO VAN TONDER: I think there are two approaches to follow to deal with the risks that you outline, and they are indeed very real. You do not want to start off your pension investment with a big capital loss. So there are really two strategies to follow.
The first one is to make sure that you diversify – preferably through some unit trust fund – across a wide range of shares. Anybody who picks individual shares in their living annuity needs to really know what they are doing, and I would strongly advise most people to rather not do that. So you sidestep the risk of having excessive equity exposure to a specific share.
The second strategy that you need to keep in mind, and those are particularly useful at the moment, when there are lots of fears around; we’re looking at the longest bull run in the US stock market, we’re looking at the Nasdaq, political considerations affecting our market’s position, and a lot of general negativity around the state of the economy. Clearly at times like these one wouldn’t go straight into a 60% or 70% equity portfolio. So our suggestion to pensioners who find themselves at the point of having to invest today: remember that your investment is a 30-year investment – you can afford to take three or four years of that 30 years and phase your portfolio in. So you start off with almost all of your pension pot in fixed income, but on an annual basis or every six months, you convert a component of that portfolio into the target portfolio, which has a much higher equity exposure. So that come three or four years down the line, you are effectively invested 60% or 70% in equities but you didn’t make that investment at one particular point in time. So you almost spread your market-timing risk over a three- to four-year period.
Ideal investment ratios
NOMPU SIZIBA: I know it depends on the individual, but just broadly speaking because we’re having a general conversation here, what are the ideal ratios in terms of the amount you invest in fixed income assets vis-à-vis equities.
JACO VAN TONDER: So generally I would say you should not really have less than 30% to 40% in equities and the other 60% you can have in fixed income. That’s your starting point for people who have saved a lot and who are able to start their pension investment off with income draws of 2.5% to 3.5%. If your initial income draw is 4% or 5% you absolutely need to increase your equity exposure – I would say to about 60% minimum, and then the other 40% you can spread between listed property and some other fixed income-based investments like income funds, for example, and a little bit of cash on the side as well.
NOMPU SIZIBA: Lastly, Jaco, assuming the investment strategy is paying off and you’re drawing an income that works for you and your fund is flush but unfortunately you pass away, can that fund now be transferred to a beneficiary?
JACO VAN TONDER: Yes, that’s one of the key differences between whether you pick a guaranteed annuity or a living annuity. Generally speaking with a living annuity the assets that are left when you pass away, those assets are 100% preserved for beneficiaries who you, as the pensioner, have nominated.
Whereas in the case of a guaranteed annuity that’s one of the downsides generally – there’s either a very smallish benefit payable or no benefit payable to beneficiaries.
NOMPU SIZIBA: Thank you for that information, and thank you for the discussion. That was Jaco van Tonder, he’s the advisor services director at Investec Asset Management.
Brought to you by Investec Asset Management.