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Will you run out of money in retirement?

Reader’s questions answered.

Cape Town – In this advice column Robin Gibson from Harvard House answers a question from a reader who is concerned about his retirement savings.

QI am 73 years old and recently retired. My wife is now 80. We are currently withdrawing R37 500 per month from our equity portfolio of R4.2 million that is handled by my investment adviser.

What is frightening me is that at the rate our investment is going down we won’t have anything left in a few years time. My financial adviser is telling me that we must be patient as all will be well after three years, but that seems like too much of a risk to me.

Currently we save R20 000 from our income every month. This is because I used to give my wife R40 000 every month before I retired and she always saved half of it. We have continued to do that and have around R400 000 put away.

Please could you advise what we should do?

Your question epitomises the essence of every pensioner’s concern: “will I outlive my money?”

There are a number of things to consider here. Firstly, we need to think about your age. It is becoming increasingly common for people to live well into their 90s. For you and your wife this means that you have an investment horizon of anything between ten and 20 years, or possibly longer.

The second thing to take into account is inflation. Even assuming a modest inflation rate of 6%, your rands will lose almost half of their purchasing power in ten years. This means that your income has to also grow against inflation. If you don’t believe the published inflation statistics or if your own ‘personal inflation’ is higher, then you will need your income to grow even faster than that.

That said, the only two investment classes that have realistically done that over all periods are equity and listed property. That leads to our next consideration, which is market risk.

These two asset classes experience capital volatility over the short term, yet over time the patient investor is amply rewarded. It is almost guaranteed that property busts and market crashes will surface, but what matters is how you respond to them.

What many people do not realise is that equity and property have two very distinct aspects of their return. The first one is income, in the form of taxable distributions in the case of property, and dividends in the case of equity; and the second is capital growth.

What is important to appreciate is that the income can still be there even when capital value drops. Using the example of a property, while it is entirely possible that a building can lose perceived value in the eyes of a potential purchaser, it remains highly likely that a tenant is still in place and paying his rent.

Likewise, a business may be unloved by the market and its share price can go down, but this does not necessarily correlate with lower profits and dividends. In fact, history proves that income streams often remain resilient even when capital values drop. We would argue that this is where asset managers really add value – identifying and investing in those companies that will pay reliable dividends through the cycle.

Consider that currently a blend of listed equity could buy you a dividend yield of anywhere between 3% and 4.5% per annum. A listed property portfolio could probably generate around 7% per annum. We would expect over time, both these yields to grow relative to inflation, and greater than inflation. This would mean that if your monthly income was generated solely from these yields, then the capital movements would be of far less concern to you.    

Let us therefore now consider your specific circumstances:

Your current income required: R37 500 per month

Current Capital Available: R4.2 million

Therefore your income yield required = 10.714%

This required yield ignores the cost of investing, which we are unable to assess from the information provided. Nevertheless, it still exceeds all current yields on all asset classes. This means that there has to be a redemption of capital, and thus it would appear that your fears about your capital depreciating are well founded.

However, if we consider that you are saving R20 000 every month and have a pool of emergency cash, then your position looks quite different.

If you eliminated the money you are saving, that would bring your actual required monthly income to R17 500.  That means that the R400 000 you have already accumulated is effectively 23 months of reserve income. That is if you use only this money and draw nothing from your equity portfolio.

Let us then assume that you have a balanced portfolio of 70% equity and 30% property and  that you pay costs of 1.75% per annum. (If your costs are higher, you should shop around for a better alternative) Using the above yields, your position is actually as follows:

Your 70% Equity provides R102 900 per annum at 3.5% yield.

Your 30% Property provides R88 200 per annum at 7% yield.

That gives a combined income of R191 100 per year.

If you subtract costs of R73 500, that leaves a net income of R117 600, or R9 800 per month. This income can be paid across into your savings without you having to touch the capital.

If your R400 000 is then invested in the money market at 5.5% interest and the income from your equity portfolio tops it up, this would provide an income for 60 months, or five years, at R17 500 per month before it drew down to zero.

In the meantime, your portfolio only has to produce capital growth of 1.82% per annum to rebuild to R4.6 million, or at 7.83% per annum to take it up to what would be an inflation-adjusted equivalent. I don’t think these figures are excessive in a growth portfolio over the next 5 years.

In short, you need not abandon growth assets. Even though the markets are likely to be turbulent for some time, the income and capital growth together should still serve you well.

In addition, you should ensure that your costs are appropriate for an investment portfolio of this size. By no means should this figure exceed 1.75% per annum, and in fact a private client operation should be significantly cheaper than that.

Finally, while I understand that the saving habit is a good one, stressing one investment to build another does not really make sense. At this stage of your life, you should be enjoying your money.

Robin Gibson CFP ® is a director of Harvard House Investment Management in Howick.

If you have any questions you would like answered by financial planning experts, please send them to editor@moneyweb.co.za.

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COMMENTS   14

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what an amazing non-answer! surely to answer this question – you need 2 things – 1) how long am I going to live and 2) how much do I need to live on. as regards 1) there are excellent actuarial tables available suggesting your life expectancy . as regards 2 – this should be freely available. you then multiply 1 x2 + inflation and that’s the lumps sum required.

Those tables are averages so if you use the table you will have a 50%? chance of living longer, so any “answer” that has a 50% chance of being wrong would also not be an answer to such an important question as this.

So where does Mr. Joe Sixpack pick up his handy Actuarial Tables for Dummies?
The CNA, Waltons?

I think the wife’s saving and budgeting skills are fantastic! Tell us how two people live on R17 500 per month?

Not so difficult. My wife and I plus pets live in a small town and live on R11000 per month. And we live well.

Given the investor’s age (73 & 80 yrs), they should stay away from high risk investments (such as equity and listed property) and stick to simple, low risk investments with minimum administration fees. My advice for this elderly couple is: invest the full R4.2 million for 5 years with RSA Retail Bonds @ 8.75% p.a. or invest with Capitec @ 9.5% p.a. Invest the R400,000 in a savings account and keep it as a contingency reserve (for emergencies). Transfer R30,000 p.a. from your savings account into a tax-free savings account to save on income tax. Limit your monthly expenditure to R20,000 (plus annual inflation). Enjoy the rest of your life.

Good advice Ham. Or, drop the financial advisor and look at 10X or Sygnia. They have low risk options that are very cost effective!

Ham – this sounds like a typical investment advisor tack – be conservative in your older age – nonsense. Both parties have a life expectancy of 10 to 20 years. Markets are seldom depressed for more than 5 years on a cycle. We had a market calamity in late 2007 and the markets recovered significantly since then to the point that our own ALSI achieved an all time high on April 24th, and currently stand at 2,000 points short of this all time high. It is a fact of life the older you get the greater your medical expenses are, and with SARS looking at not giving you any tax breaks on own costs of medical costs these will eat into income. So simple one can’t be too conservative there has to be some funds in higher risk (not crazy high price fluctuating penny shares) consistently good performing stocks. Check out what high care costs are to the aged, you will be frightened

grahamcr – given their total portfolio of over R4 million, they can maybe invest a quarter of their portfolio in equities. But, remember, the returns on RSA Retails Bonds are guaranteed and it should be enough to carry them through for the next 10 to 15 years. And if they live longer than that, then let them cannibalize their own investments (before financial advisors and institutions do it anyway with high charges on equity investments).

If your costs are higher than 1.75% you should shop around… Rubbish. If your costs are higher than the lowest cost ETF in that sector you should shop around. Giving away 38.4% of your annual earnings (as in the example above) is criminal. What did the fund managers do for that money, beat the market? I bet not! They’re far wealthier than you are, you don’t need to give them any more money.

Whoever advised him to draw R37 500 ehen he only required R20 000 every month thus losing all the growth in his equity portfolio?

He is drawing too much. Killing all the growth potential in the ptfolio.
1) On R4.6Mill invested drawdown of R37 500pm, 9% incr in income drawdown pa and if he only gets 9% net growth, Capital depletion is in 11yrs and 9 months.
2) On R4.6Mill invested drawdown of R17 500pm, 9% incr in income drawdown pa and if he only gets 9% net growth, Capital depletion is in 23yrs and 8 months.
If he hasn’t had a positive growth figure in his ptfolio in the last year, even if it is small then change advisors for better advice and growth. 70% equity max including listed prop equities, the bal in bonds and other. Active & passive mix, multi manager, FOF included and not more than 6 funds.

I am not a financial adviser, but from all the books and articles I’ve read to improve my own financial intelligence, the following things should be of interest.

1. Withdrawal rates. Historically in South Africa, the maximum safe withdrawal rate is around 3.8% from a portfolio consisting 75% equities and 25% bonds. Search for Trinity studies if you want more information on this. You have 4.2 million, so the maximum safe amount you can draw is R13300 per month.

2. Emergency cash/cash buffer. Keep 6 months of living expenses in cash (money market account paying around 5% interest). The rest should be invested in equities/bonds and property.

3. Fees. These are very important to look at because if the safe withdrawal rate is 3.8% and you are handing over 1.75% to your adviser, there is not much left for you to live on. Your best bet is to buy index tracker funds/ETFs. They charge much lower fees (less than half a percent in most cases) and will never under perform the market, they simply track the market average.

4. Housing. If you own your home, consider down scaling and investing the difference. If you still have a home loan to pay off, do it now.

Thanks MoneyChief, some great ideas. My thoughts: The main thing about retirement is to go into it with zero debt. Debt is too expensive to service in retirement, this is the one thing that is non-negotiable for all retirees.

The second key aspect is income. You need a diversified stream of income to cope with all economic conditions. Don’t rely on one source of income and don’t cannibalize your assets.

A few other points:
1. You don’t know how long you will live for so just focus on the income aspect, make sure you have a diversified inflation matching income stream generated by your portfolio of assets.

2. Don’t pay ongoing fees wherever possible, they eat away at your annual income. % based fees are your enemy. 1,75% of R4m is R70 000 per year! Does an adviser deserve this? Would you pay your tax planner R70 000 a year to do your tax return?

3 You can’t take your capital with you when you die, leave the income generating assets to your spouse and then when your spouse kicks the bucket, pay the tax and leave the rest to the SPCA, Church, Childrens hospital, whatever. Keep it simple!

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