I went on an early pension. I put my pension in a money maximiser account at my bank; it is not a lot of money. Is this the right thing to do?
Your question is very important however, it encompasses an array of factors which shouldn’t be taken lightly nor answered in a brief response. I would urge you to seek comprehensive advice from a qualified professional financial advisor, to be fully informed on your options and what possibilities may be appropriate for you.
When investing your retirement savings, there are several aspects which need to be considered to know what the appropriate investment options are. Without the essential information in which to better understand your circumstances, I will discuss some of the considerations which may be relevant to you.
There are many aspects to consider when formulating an appropriate investment strategy. Some of the important considerations are the following:
- Risk profile: How much risk are you able and willing to take, given your unique financial circumstances and overall risk profile? In other words, are you a conservative, balanced or high-risk investor?
- Investment time frame: How long are you prepared to invest the money without having to draw on a large portion of the investment?
- Income requirements: Do you require an income from your investment and if so, how much income do you require relative to the capital?
Know the risks of investing too conservatively in retirement
You are in a fortunate position to have had your pension in a money maximiser account, given the market crash that we are experiencing. Research has shown that to maximise the longevity of your pension fund, you require an appropriate exposure to growth assets which can and will experience periods of volatility. The extent to which you include growth assets in your portfolio depends on the three considerations that are mentioned above.
Holding your pension fund in cash for an indefinite period could lead to longevity risk in your investment capital.
This link refers to a presentation which was presented to financial advisors by Pieter Hugo, managing director of unit trusts at Prudential Asset Management. The presentation is fairly long (32 minutes) and in some areas it’s fairly technical for the average investor. However, it is such an important presentation for investors to watch as it relates to your financial security during your retirement.
Basic investment options
I am assuming that the pension fund which you mentioned is either your sole retirement savings or a large portion of your retirement savings and that it needs to provide an income for you in your retirement. Based on that assumption, your options are to:
1. Buy a guaranteed annuity. For investors who are unable to take on any risk and who require a relatively high degree of income, a guaranteed annuity isn’t a bad option to consider. If you were to consider this option, you’d need to be advised as to which institution you should use, and which guaranteed annuity options to consider.
2. Invest in a portfolio of multi-asset funds which can provide for both capital growth and income in retirement. This is, of course, subject to your risk profile, investment time frame and income requirements among other things.
3. Continue to hold your pension fund in cash or cash instruments such as a fixed deposit or flexible income funds.
Each investment option comes with its advantages and disadvantages which should be better understood in the context of your financial circumstances, through the help of a qualified, professional financial advisor.
Your withdrawal rate matters
It is important to note that South African investors should target an annual withdrawal rate of 4% or less. This Allan Gray article details why the 4% rule is so important. It was also discussed in Hugo’s presentation.
Investors who require a withdrawal rate of more than 5% run the risk of depleting their savings while in retirement.
Investors who can’t reasonably afford an annual 4% withdrawal rate should consider a rate of 5%.
South Africa is going through what is arguably one of the most difficult economic periods experienced over the last several decades. Our debt levels are unsustainable, our business confidence is at extreme lows and we have repeated issues with the supply of energy and in some cases water. The inevitable consequence of this environment is that companies need to reduce their costs, which means that some employees are retrenched or offered an early retirement package.
These lost years of employment can have a significant impact on the sustainability and long-term viability of an investor’s retirement savings. The somewhat uneasy conversation with investors who find themselves in this position is around them finding an additional source of income which can supplement their financial requirements for as long as possible.
The idea of finding an additional source of income is easier said than done in the current economic environment. However, it’s something that needs to be seriously considered where necessary.
The right decisions for you as an investor depend on your unique circumstances. The presentation by Hugo puts into perspective the fact that investors need to have the appropriate level of income relative to their capital. Investors also need to have the appropriate exposure to growth assets, as well as to manage their emotions when it comes to investing: don’t react to the one- or three-year performance in the market. Investors can typically retire over a 20- to 30-year period.