The cash glide: an alternative to Reg 28?

A theory on paper: a life-stage retirement-saving model allocating everything to equities and not reinvesting dividends.
The author ponders an alternative to the Reg 28 maximum 75% in equities restriction. Image: Shutterstock

Common thinking on the street is that, as you get closer to your retirement date, you should de-risk your portfolio by reducing your allocation to equities, and have more of it in safer stuff like cash and bonds.

And that thinking is pretty solid – imagine working for all of 40 years and then, just as you are about to retire, the market pulls a Covid-19 on you, wiping out a third of your capital because you had everything in equities.

This would translate into 33% less income for the rest of your days – nasty.

For this reason, some retirement products have built in airbags which will reallocate more and more of your portfolio into safer assets as you get closer and closer to retirement. It’s usually called a life-stage model and I reckon it has been (and will likely continue to be) a life retirement saver for many.

These life-stage models have defined asset allocations at particular points on your retirement investing journey. For example, with ten years to go till retirement, they will put you into 40% equity, 60% bonds/cash, and then with five years to retirement you get 25% equity and 75% bonds/cash.

And this got me thinking….

Could we maybe achieve something similar, but without a fund:

  • Needing to take any active decisions (e.g. when to sell and buy and in what allocations)
  • Needing to incur the costs of selling something and then buying something else

Now the below is far from perfect, but it is kinda interesting (well to me at least…)

Imagine someone starts their retirement investing journey right at the beginning of their career. Now, in my view, there is no reason why this person, with around 40 years of runway ahead of them, should not be fully in equity.

So let’s assume they allocate everything to equities. Let’s also assume that equities deliver a 12% annual return, with the caveat that 2.5% of that return comes from dividends.

And now the engine behind my idea. Go against everything you have learnt about long-term investing and don’t reinvest those dividends.

That’s right – we leave the dividends in the account as cash, where it earns interest of 6%.

My calculations* around this strategy leave you with the following asset allocation percentages:

  % Equities allocation % Cash allocation
Start (40 years to retirement) 100% 0%
After 5 years (35 years to Retirement) 92.93% 7.07%
After 10 years (30 years to retirement) 87.66% 12.34%
After 20 years (20 years to retirement) 78.89% 21.11%
After 30 years (10 years to retirement) 72.35% 27.65%
At retirement 67.61% 32.39%

* I calculated the results using an annual investment (instead of monthly) and as if the dividend is paid on the investment balance at the end of each year.

And the full ‘Cash Glide©’ (that’s what I’m calling it, patent pending) over time is shown below (click for larger image)

Source: Stealthy Wealth

After starting with 100% in equities, this person’s asset allocation would have slowly self-adjusted to around a third cash by the time they are ready to retire. Now that is still probably a little high in terms of equity exposure, but it does lead me to an interesting thought around Regulation 28 and pension funds…..

A different approach to Regulation 28
Just a quick recap, Regulation 28 (or Reg 28 as the cool kids call it) are rules which govern how you can allocate your investments inside retirement funds (pension, provident, preservation funds and retirement annuities or RAs).

In a nutshell, the regulation says that at least 70% of your funds need to be invested locally, and no more than 75% in equity (which is one of the nine reasons I do not like RAs).

Now I am not going to get into the politics around forcing investments locally (there will be enough of that once corona blows over and we are back to headlines around prescribed assets), but I do want to maybe offer an alternative to the maximum 75% in equities restriction, just as a bit of a thought experiment.

In my view, there is no reason not to allow someone at the start of their working careers to invest 100% into equities if they wanted to.

With such a long-term view, this will surely give them the best shot at the best risk-adjusted returns, and we are not doing them any favours by capping them at 75% if they are happy to take on more equity exposure.

So how about scrapping the rule that says maximum 75% in equities, and instead make a new rule – no re-investment of dividends allowed.

That way you could force an investor’s exposure more and more into cash as they get closer and closer to retirement. This automatically reduces their risk as their retirement date approaches while at the same time not penalising young savers too much.

Just an interesting thought….

And of course this approach is super easy in theory, not so much in practice – how do you handle total return funds, and what if someone only starts their pension product at a later age?

Anyways, would love to hear your thoughts? (It could just be that I am smoking my socks because looking at these same four walls for over 50 days has made me a little batty….

This article was first published on Stealthy Wealth here, and republished with permission

COMMENTS   16

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Love the simplicity of Stealth Wealth’s reasoning, yet though providing and sensible.

Reg 28 made me chuckle 😉 How about replacing Reg 28 with “Regulation 29”!! It would make sense:

1% in SA assets
99% in Mauritian assets

(?)

I guess if a small % of SA wealth flows to MAU over time, it could only lift their (smaller) stock market & economy in leaps and bounds. Or am I missing something….(?)

On another note: cudos to Mauritius for now having zero Covid-19 cases 🙂 By the magic of coconut juice! It’s AS IF they live on a friggen protected island!

To not automatically re-invest dividends back into the same equity share, but to allocate it to i.e. bonds or fixed coupon rate preferential shares, is a sound risk-adjustment strategy over the longer term – for both compulsory (retirement savings) and for discretionary (private) savings.

One should however take cognisance of the following for optimal deployment of scares capital provisions:
a) utilising the tax deductions applicable to retirement savings alternatives such as a Unit trust- or ETF based retirement annuity (R.A.)
or a retirement fund (pension- or provident fund). This can increase the
invest-able contributions by up to 40% per annum.
b) that Regulation 28 – specifically regarding limits to prescribed asset allocation – never has been and currently still do not apply to the investment asset allocation of a living annuity (a post retirement pension generating product). A general misconception very many people have.

It’s difficult to be a great fan of any particular pre-retirement strategy without a post-retirement strategy to go with it. Most private sector pensions these days are living annuities – it makes no sense to reduce the equity component in the lead-up to retirement if you then need to increase it again, unless your fund is way more than you need or your life expectancy is atypically short, in which cases growth may not be a concern.

Absolutely agree. The approach in SA is to ignore or compound the problems associated with transitioning to a living annuity.

12% return per annum with regulation 28? ‘major lols’
The best strategy is to remove reg 28 all together. I keep my pension fund 70% money market and 30% in a 4IR fund. I survived the Covid mess. And now I’ll get some local equity at the cheap while continually keeping my foreign allowance at 30%

Foreign Allowance of 30 % is fine – but your Dolla/Rand exchange rate leg is 100 % uncovered and at risk – maybe its time at these lofty levels to take out a collar structure to protect that?

Excellent article and good thinking :
I have done a calc that after 12 years in a LA , I would have been better off if I had had a Fixed deposit (or RSA Retail bond) for the Full period :
This takes account of Tax on the FD & of Course LA Managers Fees:
No Volitilty ,peace of mind etc but NO the Govt decides I cant do this (with my own money)so i,m stuck with a LA (unless I swop for a Guaranteed Fixed Annuity & chuck the Capital away ) :
I would recommend NEVER getting into any pension situation where upon retirement the Govt can still dictate what choices one has re utilising yr Pension.

agree…money market in a reg28 outperformed the last 10 years if not longer….and yes you can place your reg28 in cash. warning on bonds . we are junk. if yields increase offshore, the big outflows might start.

Very good idea. Presumably easy to implement by service providers.
Once hitting retirement date the portfolio can morf nicely into a bucket allocation strategy.

A painful twist brought to you by SARS is that you will have to sell all assets to obtain the R500k tax free amount.

Hope you don’t hit a corona event in the process while dealing with SARS.

Which companies still pays dividends

Nobody knows. Everybody is advising with 100% hindsight. All we know is that even when retired one can live another 30 years. We also know that equities makes the most money over time. We also know that 9% growth per year may not be enough.
So, flip a coin and live with it.

Hi Micheal. I like your thinking. You can buy commercial property in Mauritius with a dollar rental yield of 6%, adjusted to inflation annually, and with no land tax and maximum income tax of 15%. And no dividend tax or inheritance tax. And not any exchange controls.
And before I forget…no EWC.
Why are people in SA still buying property?

Because they never took their money out like you told them to Magnus !!!

Hey Magnus, when were you allowed back, we missed you….

In all honesty Reg. 28 has been a dead horse for so long now and yet we are still forced trying to get it to gallop. Flogging a dead horse must look comical to all those who are able to invest their retirement monies wherever they wish in a genuine free market system. Imagine we could’ve invested as we wished into global equities and how much better our retirement portfolios would be looking now if that were the case? At the very least we all would’ve consistently have beaten real inflation over time? Pegged to Reg. 28 a very weak currency and very little prospects for the local economy for the next 5 years (at the very least – think the now fast looming load shedding again and now spiraling unemployment – thank you lockdown) and you are stepping into another perfect storm. Reg. 28 should be scrapped as a grossly inefficient way to invest for retirement and to expose it for what it actually is : more government enforced exchange control. RSA has a massive retirement savings pool and should the majority of those funds flow outwards from RSA to where the real opportunities lie (Mauritius was put forward here by some more informed than I – thank you Magnus) then I think government would proverbially wet their shorts and choke on their Beluga caviar.

If equities return 12%, and dividends are 2,5%, and the historical real (after-inflation) long-term price appreciation of equities is 3%, this implies inflationary growth of 6,5% pa.

But your long-term interest rate is only 6%. Why would anyone want to invest in cash in a model that delivers a negative long-term real return?

Not that any decent model would predict a long-term nominal interest rate because that would depend on the inflation rate, and no one knows what long-term inflation will be. That is why such models work with real, not nominal returns, because there is some logic or pattern to these.

I am also scratching my head as to why you would invest contributions for 40 years into equities, but dividends into cash. Why not let your index fund automatically re-invest dividends and just put some of your contributions into cash?

But this is just the tip of the iceberg. Did you consider fees and tax in your returns? There is no mention to the products you would use to hold your investments. You are also suggesting no bond investing (you don’t appear to understand how portfolio diversification can improve on the return of the best performing asset class) and already having 20% in cash after 20 years.

Then you end up with two-thirds in equities at retirement, which is still pretty close to a high-equity portfolio. Where is the airbag you talk about? And of course no thought as to how you would invest post retirement, because that should determine your de-risking glide path.

End of comments.

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