I will be retiring from work within the next few months. I am considering investing R500 000 of my pension fund payout into RSA retail savings bonds for a fixed period of five years and another R500 000 into an FNB fixed deposit for five years. Is this a wise idea?
It’s important to note that your question forms part of a greater whole which is to say, what role does this money play in your long-term financial plan?
Without knowing the role that it plays in your overall financial plan, I will address the considerations around using fixed income instruments, as well as the considerations for an investor who is starting out their journey in retirement.
The place for fixed income instruments in retirement
Fixed income instruments are typically associated as low-risk investments which don’t fluctuate significantly in value. This makes it a great option for short-term investments or for investors who prefer low-risk investments.
The danger of fixed income instruments in retirement
The conversation which isn’t often had with investors who are looking at fixed income instruments is the risk that over the course of their retirement, their pension fund is unable to keep up with their income requirements while also growing their investment capital by the rate of inflation. We call this longevity risk – the risk of outliving your retirement savings.
For the typical investor, they would need to have an appropriate mixture of both fixed income and growth assets in their portfolio in order to provide them with a reasonable level of a sustainable income in retirement. This suggests that investing in fixed income instruments over a long period of time could lead to a higher longevity risk for retired investors. This is, of course, subject to the context of the investors’ financial position.
Using a multi-asset fund to access both fixed income instruments as well as growth assets allows for the flexibility to move between asset classes as and when the investment manager sees value.
I would encourage you to watch the webcast that was put together by Allan Gray on the topic of managing a living annuity in retirement. It helps to show retired investors what the research suggests regarding their investment and income in retirement. It’s important for a retired investor to appreciate the financial planning principles which form part of a successful financial plan.
Retail savings bond
The current rates of retail savings bonds appear to be relatively attractive, considering the interest rate on cash in the bank. The question is what are the dangers?
On the one hand, there is the danger of sovereign risk where the government is unable to honour the terms of the agreement and you lose either all or a portion of your investment. That’s probably quite a low risk but one that more and more investors are becoming concerned with.
The other risk is an inflationary risk. The current rate for a nominal retail bond as quoted from their website is 8% per year over five years. If the rate of inflation – which is relatively low at around 3% – were to inflate to higher levels of around 6% to 7% per year, this could effectively leave you with a negative net return over the period after paying tax on the income.
One could consider a combination of both a nominal bond and an inflation-linked bond to help mitigate the inflationary risk over the next five years.
Cash in the bank has been relatively attractive over the last five years while South Africa has had relatively high-interest rates coupled with a stock market which has traded sideways over that time.
In an article on Prudential Investment Management’s website, its head of communications and media, Lynn Bolin, said the following: “Investors have been understandably worried about investing in equities in this highly uncertain environment, and many are taking the ‘safer’ option by staying in cash. But the environment in which we find ourselves has changed dramatically since the start of the year – interest rates have decreased substantially and the prospective returns from equities are looking significantly better compared to cash.
“To demonstrate why we believe opting for cash is likely to be an unwise choice for long-term investors, the below graph shows how equities have historically outperformed cash in times when interest rates are low, back to 1965.”
Interest rates are relatively low, and they are forecast to fall further. This makes cash an unattractive asset class for investors, yielding relatively low real returns (returns net of tax and inflation). A five-year time frame in cash could be seen as a lost opportunity for growth. If, however, your time frame was 12 to 24 months, then cash in the bank would be appropriate given the risks in growth assets over such a short period.
“More people lost money waiting for corrections and anticipating corrections than the actual corrections,” said Former Fidelity fund manager Peter Lynch, last year.
If you are concerned about risk and volatility over the next five years and are thus considering cash and bonds as an alternative, you could consider using multi-asset low equity funds as an alternative over a five-year period. The living annuity webcast that Allan Gray hosted shows the risk of taking too much risk and too little risk in retirement and how it affects sustainable withdrawal rates.
I would encourage you to seek holistic financial advice in order to get the most appropriate advice in relation to your overall financial position and long-term goals.