Those in the retirement industry bemoan the fact that South Africans are poor savers and are often one emergency away from trashing what savings they have.
There are a few immutable truths about retirement savings that are often overlooked:
- Start early and put 15% into retirement savings as soon as you start working.
- Worry less about which investment house is managing your money than the end goal of maintaining a decent standard of living when you retire.
- Never touch your retirement savings for any reason, not even emergencies.
- Plan for a long life, well beyond the retirement age of 65.
The graph below illustrates what happens when you invest 15% of your earnings from the age of 25 and keep this going throughout your life, while earning a suitable level of investment return.
The bars in the graph show the person’s income throughout their working, as well as their retired, lifetime. The eye-opening insight from the graph is revealed by breaking down where the pension amounts actually come from, as summarised in the table on the left. The amount you will spend in your whole retirement is derived from three sources – (1) the contributions you make, (2) the growth on those contributions up to retirement date and (3) the growth on your investment post-retirement, i.e. when you are drawing out your pension.
A mere 6% of your retirement money comes from the contributions you made while working – the remaining 94% is generated from returns, of which only one third was generated before retirement. A massive two thirds was earned while you were retired. This assumes that you are earning a market return of 5% above inflation in the years prior to retirement, and 3% above inflation post retirement.
“That’s the power of investing for the long term and letting compound interest do its thing,” says Andrew Davison, head of advice at Old Mutual Corporate Consultants. “The contributions you make as a proportion of your retirement pot are minute when measured over the long term, but you have to make them early. This also shows how important the post-retirement phase is and hence how important your decisions are in relation to the annuity you use.”
Getting this message across to South Africans is not proving easy. Year after year, Old Mutual publishes its Savings and Investments Monitor which shows how poorly South Africans are saving. The latest survey shows that just one in three ‘baby boomers’ has any form of formal retirement saving.
There’s no easy way around this, says Davison: “We focus on getting people to have a retirement plan in place so they don’t get distracted by fads and get-rich-quick schemes that are supposed to get you there faster. The main thing is to have patience. People want to see quick returns, and this lack of patience can be disastrous. If they save R1 000 a month and at the end of the year they see just R12 500, they start to question why they are putting in all that effort for such little return. But the returns come much further down the road.”
Taking the tortoise route to wealth creation
Davison relates the story of one corporate client who invested in a portfolio in 2006. “I converted their annual return into a rand amount and explained that if they had invested R1 million in 2006, they would have R4 million today. They were quite surprised, but pleasantly so.
‘They started to see that the tortoise moves slowly, but makes steady progress.’
Those looking to accelerate the process are drawn into riskier investments, such as cryptocurrencies. While cryptos have made huge profits for some, the record so far this year has been abysmal. “At the height of the crypto-craze in 2017, people started asking why we don’t invest in crypto currencies. Our answer was that we believe in investing, not speculating,” says Davison.
On the other side of the risk ledger, holding cash is also not advisable. It is also risky but for different reasons: it’s not volatile so people perceive it to be low risk but the reality is that it does not generate sufficient return to beat inflation by a wide enough margin, a key requirement for retirement savings.
Three main reasons for saving
Davison says there are three major reasons for people to save:
- Retirement (not preserving savings when changing jobs is a problem, even if used to pay off debt)
- Education for children (if applicable).
He recommends making sure that all three of these needs are met in one’s financial plan and that the savings are appropriately segregated. This is to ensure that any emergencies that arise do not eat into the retirement or education funds. Many people save diligently for retirement until an emergency arises, then cannibalise their retirement funds. Although this is better than borrowing to handle an emergency, it isn’t advised because it’s so difficult to catch up on retirement savings when they’ve been used for other purposes.
“It is preferable to have separate, short-term savings to deal with emergencies, and to never allow anything to start eating away at your retirement savings.”
Another problem common to South Africans: failing to preserve their retirement savings when they change jobs or retire. There has been some debate in the investment sphere over the wisdom of using retirement savings to pay off debt, such as the mortgage bond.
There are a few reasons why this isn’t advisable, says Davison. Firstly, there is tax to be paid when you withdraw from a retirement fund. Even if the interest rate on the debt is slightly higher than the returns you are getting on your savings, the impact of tax could sway this comparison in favour of leaving the savings invested.
Secondly, the problem with paying off debt first is that it requires the discipline to then avoid taking on more debt. More importantly, it’s essential to catch up on retirement savings. To do this you need to continue your retirement contributions while also redirecting the amount you would have been paying on debt repayments towards retirement savings. If you don’t do this you won’t fill the hole created when you raided the savings to pay off the debt.
Retirement fund trustees spend a lot of time choosing asset managers and deliberating whether to change managers if they have a period of underperformance. In terms of the impact on eventual retirement outcomes for members, this isn’t the most impactful decision. Trustees need to identify which decisions are the most impactful and spend their time accordingly.
Spending time understanding the objectives, setting (and encouraging) appropriate contribution levels, assisting to make preservation simple for members who leave, excellent communication to members and ensuring that the investment strategy is designed to deliver superior long-term growth by having appropriate levels of growth assets (i.e. the asset allocation decision) are all more impactful decisions than deciding over exactly which asset manager to invest with. This is also certainly more valuable to members than switching back and forth between managers based on trying to be invested with the best performing manager at all times.
The same can be said for trying to decide between active and passive investments. It’s far more important to ensure that you are paying a reasonable fee for the type of portfolio you have selected and then staying put for the long term. Once again, patience is important. Switching between different styles or different managers is likely to destroy wealth for members.
Saving for retirement is simple but it isn’t easy. As a trustee, you can help members by focusing on the decisions that have the most impact on their retirement outcomes. As a member, it’s important to take responsibility for your retirement plan and have the discipline to execute it, the patience to let compound interest work its magic and the resilience to sit tight when the ride gets bumpy.
Brought to you by Old Mutual.