CAPE TOWN – In this advice column, Robin Gibson from Harvard House answers questions from two readers who want to know which investments would be best for their retirement.
Q: I have a lump sum of R150 000 which I would like to invest so that it grows reasonably. Could you please give me some advice? I do not need to have access to the invested money immediately as it would be provision for my retirement. I have some other provision for retirement held in accounts in England and Jersey.
Without knowing the specifics about your time horizon until retirement, I would give the following generalised advice.
Investors need to decide what is more important to them: the absolute value of their investments or the income stream they generate and their long term structure. In the past, retirees would generally use their retirement funds to purchase the most advantageous annuity from an insurance company or pension fund. Today this is seldom the case, with research from National Treasury showing that annuity purchases have decreased to less than 40% of all compulsory retirement funds.
If your goal is to buy an annuity, then a large decrease in your capital value just before retirement would be catastrophic. So if that is your intention, then your investment goal should be to generate compounding income with low capital volatility. This might mean a mix of strategic income funds, property portfolios and low risk, high dividend equity strategies.
However, if your intention is to manage a portfolio of investments that you draw down on over the full length of retirement, then your time horizon and investment objectives change quite notably. These days people are often retiring before the age of 60 and then living beyond 90.
This is likely to become increasingly common, and represents an investment time horizon of more than 25 years post-retirement.
The challenge is that many retirees or imminent retirees worry about capital volatility in their investment portfolios. However, without exposure to growth investments, and specifically equities, there is little chance that a retirement portfolio will last the distance. A portfolio built too conservatively to protect against volatility is going to become the victim of inflation in the long run.
My rough approach to this lump sum in such a case would therefore revolve around a 60/40 split of equity to property funds if the time horizon to retirement is five years or fewer. I would add an extra 10% of equities for every for five additional years that you are away from retirement. For example, if retirement is ten years away, then the split would move to 70/30 and if it were 15 years away, it would be 80/20.
It is also vital that you consider the question of costs. I would want to ensure that the total cost of investing, which includes advice, administration and asset management, does not exceed 1.5% per annum.
Q: I am 72 years old and will be receiving R2 million in October. I need to invest it with minimum risk and to receive monthly income of about R10 000. What should I do?
The place to start is to calculate the yield that you need from your money. This income represents R120 000 per year, which expressed as a percentage of the capital sum gives us the required yield i.e. R120 000/R2 000 000 x 100 = 6%.
You could easily earn this through buying an annuity from an insurance company. However this could lead to a consumption of capital and no likely return in the event of death.
The alternative is to consider the available yields in the market place:
Yields on equities, from dividends, would be around 3% per annum on a diversified portfolio
Yields on listed property in the form of a taxable dividend or interest, would be around 7.5% on a spread of listed counters.
Yields on bonds are around 7% to 8% per annum.
Yields on cash from money market funds are around 6% per annum.
These are however, ‘coal face’ yields. In other words they are what you would expect if you bought the instrument directly and for your own account.
This however is seldom the case as most investors need a number of vehicles to access these investment types. And one needs to remember that the costs of these structures reduce the yield for the end user.
The second complication that comes into play is inflation. While the yields shown above may make it look like your 6% would be easy to secure, you have to remember that the cost of living will go up every year and the R10 000 you need now will not be worth as much in five year’s time.
Bond yields do not increase annually and there is no capital gain unless future yields reduce relative to current yields, which is a difficult scenario to paint. Thus in some ways a bond is similar to a tradeable fixed deposit.
Listed property ticks more boxes as yields generally climb in line with rental increases and this can lead to capital growth too. However, one does need to bear in mind that yields can stagnate due to increased rental vacancies and capital value can decrease proportionally if interest rates increase in the coming years.
Equities might offer a paltry 3% yields, but this can be more than compensated through capital growth as directors grow the business. But this does of course come with the risk of short term capital volatility.
With that in mind, I would advise the following:
Firstly, if you are offered a product other than an annuity that has an up-front cost or commission then look for another service provider. This is like buying an iPhone 1. It is outdated!
Secondly, with this kind of capital, you should be able to source an all in fee of around 1.5% per annum at worst. If this is not what you are being offered, keep looking!
In short, you are unlikely to earn the sustainable level of income you need without being prepared to take some capital risk. A quality financial adviser should be able to produce a blended portfolio that meets the yield, cost and inflation challenges. If you dig really well you may even find one who does it for a set fee and doesn’t bust the plan before it even starts!
Robin Gibson CFP ® is a director of Harvard House Investment Management.
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