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