Cape Town – Over the last two weeks we have looked at the question of how much retirement capital you need, and how long it will last. In both cases, we made it clear that estimating how much is enough to see you through retirement is an inexact science, because you cannot predict either inflation or investment returns.
Along with how long you are going to live, which is the third great unknown, these two factors will determine how well you can live during retirement. And balancing them out is the key to a good investment strategy.
Simply put, inflation is the silent killer. Over a year or two it may not seem so bad. Whether you pay R5 for a chocolate today, or R5.30 for the same chocolate next year might appear fairly immaterial.
However, if you extend that rate of inflation for just five years, suddenly your chocolate costs nearly R7. Over ten years, you would need almost R9 to buy it.
So in order to make sure that you don’t lose any buying power, you have to ensure that you are able to turn your R5 today into at least R9 in ten year’s time. That will mean that you can sustain the same standard of living.
The only way to do that is to make sure that you are growing your retirement pot. That means investing it in a way that allows you to make withdrawals that keep pace with inflation.
The only way to do that is to take on some degree of risk. There is no such thing is a risk-free retirement strategy unless you have multiple millions and only ever need a tiny percentage of it every year.
Many retirees make the mistake of thinking that they have to be conservative with their money and that they can’t afford to invest in growth assets like shares. The truth, however, is that very few can afford not to.
Consider that, at retirement, you actually have to re-set your investment horizon. While you are working, accepted wisdom is that the closer you get to retirement, the more conservative you should become with your investments. This is sound thinking, because you don’t want a market shock one or two years before you retire to wipe out a huge chunk of what you have been saving up for decades and not have time to earn it back again.
However, when you actually reach retirement, your outlook changes. If you retire at 65 today, there is a good chance that you will live to 95 and you have to make your money last until then. In other words, your time horizon has just shot out from zero, to 30 years.
The below table might illustrate this more clearly, assuming a retirement age of 65 and a life of 30 years after that.
For someone aged 64 who intends to retire next year, it would be prudent to have the majority of their capital in safer assets like bonds and cash. However, it would be potentially disastrous for the same person to keep the same asset allocation once they actually walk out of the office for the last time.
This is because these assets will not grow fast enough to allow you to increase your income by inflation every year for an extended period. Even if you start at a 4% draw-down rate, your money would not last 30 years if it was only ever growing at the same rate as inflation, which is what a primarily cash-based portfolio is likely to give you. This is particularly true when you consider that tax and investment costs could also eat into some of what you are earning, and so your realised returns are likely to actually be below inflation.
That means accepting that assets like shares and listed property must form part of a sensible portfolio. You need the above-inflation returns these assets can give over the longer term to guarantee that your capital will last.
If your investments do well, you may reduce the allocation to these kinds of assets as you grow older, since your investment horizon will decline again. But unless you are fairly certain about how long you are going to live, you can never ignore them completely.
So what might a portfolio at retirement look like?
The important first consideration is that while you are saving for retirement your primary concern is accumulating more capital, but once you enter retirement, you now have two equally important goals – ensuring an income and growing your money. They are not mutually exclusive, but they need to be considered together.
That means building a portfolio that contains both growth assets and those assets that give you an income by producing some sort of yield. That could be in the form of either interest or dividends. This is so that, for as long as possible, you can draw your income from the proceeds of your investments, rather than having to take out any capital.
This also ensures that you are not taking on too much volatility risk. You don’t want big market dips to take out a whole lot of your money, especially in your early retirement years. So it is a careful balancing act between being aggressive enough to grow your money over time, but careful enough to make sure it lasts.
This is where a good financial adviser can add a lot of value. By looking at how much capital you have and what level of income you need, they can construct a portfolio that is right for your needs.
If you have saved successfully, you will be able to take a more conservative approach, and perhaps only have 30% of your assets in shares. If you are a little short, you may have to be more aggressive and push that number higher. However, you then have to be able to bear the volatility that will come with that.
There is no magical formula that is right for everybody, since circumstances will always differ. That is why getting good financial advice could be the difference between a comfortable retirement and running out of money before you turn 80.
The below portfolio might however serve as something of a guideline from which to start a discussion with your financial adviser:
|Local dividend-paying equities||20%|
|Local growth equities||10%|
|Local listed property||10%|
|International listed property||5%|
|Local inflation-linked bonds||15%|