Times have changed when it comes to retirement planning. Not all of the changes have been for the worse and if you are aware of them, you can plan accordingly, Peter Stephan, Old Mutual's retail legal services manager, told a recent meeting of the Personal Finance/Fairbairn Capital Investors Club in Cape Town.
The good news is that a lot more information is readily available about retirement planning and investing for retirement than was the case in the past, Peter Stephan says. Obtaining knowledge should empower you to make better decisions, he says.
In addition, Stephan says, the range of investment products is wider, and the regulation of investments and financial advisory services has improved. The wider range of products does mean that, more than before, you need appropriate advice to ensure you make the right choices.
The changes that have made retirement planning more difficult, Stephan says, include the fact that we are often forced or choose to retire earlier, but will live longer and therefore need more retirement capital.
To compound the issue, investment markets and interest rates have been more volatile in recent decades, while returns have decreased in line with declining inflation, Stephan says.
Looking back over recent decades, he says, the post-1960s were the "golden years" era of retirement. People started retiring earlier than 70 and living longer due to better health. As a result of increased contributions to company and state pension funds, people had more money on which to retire. Retirement was regarded as something to look forward to.
The 1970s were a period of relative stability both in terms of returns from equities and cash and in interest rates, Stephan says.
The 1980s saw more volatility and some steep increases in equity returns and in interest rates, Stephan says. For example, interest rates changed 44 times, moving between a broad range of 10 and 25 percent. The JSE Security Exchange's All Share index started to out-perform cash in this decade.
The volatility continued in the 1990s, he says, with equities still outperforming cash. There were 30 changes in interest rates in this decade, but the range within which rates moved started to narrow to between 15 and 25 percent.
Equity markets were still volatile at the start of the 21st century. As a result, cash was the best investment in the first few years of this century, Stephan says, but it is highly questionable whether cash will remain the best asset class in which to be invested for the rest of the decade. While interest rates have changed 10 times since the start of the century, they are more stable and have clearly started coming down.
Stephan says people near or at retirement will have to get used to the volatility in markets and interest rates and plan for it.
One way to combat volatility is to leave your investments in the market for a long time, Stephan says, as it reduces the risk. "Time in the markets and not timing the markets will deliver the best results."
He compared the returns of equity investments to those of cash investments since 1960, and found that over a rolling one-year period, the range of returns from equities can be anything from 120 percent to a loss of more than 40 percent. With cash, over a rolling one-year period your returns will always be positive, and much less volatile - between one and 20 percent.
Over longer periods, such as a rolling five-year period, the volatility of equity returns is reduced, and it is much less likely that your returns will be negative.
Over 20 years, the volatility of equity returns is significantly less and resembles that of cash investments. The comparison also shows that over the longer term equities have outperformed cash as an asset class.
Your capital can't retire
Another issue that people near or in retirement must consider is that their capital needs to grow while they are in retirement, Stephan says.
Your capital cannot retire when you do, he says. It has to keep on working for you, and the growth it earns must enable you to increase your pension so that it keeps pace with inflation.
For example, R100 000 invested at the prevailing interest rates in 1993 would have paid a monthly income of R1 000. Today, as a result of inflation, you would need an income of R1 800 a month to maintain the same standard of living. And in a low interest rate environment, Stephan says, returns from cash are low and cannot be relied on to keep your retirement capital growing at the necessary pace.
If you do not have enough growth on your capital, it will be depleted too quickly and you will not have enough to provide you with an income throughout your retirement.
For example, Stephan says, R1 million may sound like a lot of retirement capital. If you had managed to save R1 million of retirement capital during your working life and could invest it at eight percent a year, you could draw an income of R6 667, without eroding your capital base, for the rest of your life.
But if you wanted that R6 667 to escalate by a mere three percent - the lower end of the inflation rate scale - your capital would be depleted in 20 years. If you increased your income by five percent a year, your capital would only last 16 years, while a 10 percent increase would destroy your capital in only 12 years.
In order to grow your capital by more than inflation, you need to expose some of it to the equity markets. To do so, you need a plan to deal with the volatility and you have to ensure that you have a well-diversified portfolio, with some money in each of the asset classes - cash, bonds, equities and fixed property.
Stephan says you should structure your portfolio in such a way that you optimise your retirement capital to provide a suitable income with sufficient increases over time. Your aims should be the best real (after-inflation) rate of return, to pay the least tax, and, most importantly, to have an acceptable level of risk for your needs and objectives.
You need to understand the balance between income growth and capital growth, he says, and you should rebalance the asset classes that provide for these regularly.
To do all this you should seek the advice of a competent financial adviser, he says, but this does not mean you should not also keep yourself informed by finding out as much as you can about retirement planning.
If your capital is insufficient
If you do not have enough capital to see you through your retirement, Stephan says, you have five options:
- To delay your retirement;
- To carry on working;
- To lower your standard of living after you have retired;
- To start a business; or
- To accept more risk.
Of these, the first three are the best, Stephan says, because you risk losing all if you start a business or take more risk with your investments.
The saddest thing, Stephan says, is when older people risk everything in "get-rich-quick" pyramid schemes and other scams offering worthless guarantees and fancy returns out of line with the market. If you are close to or in retirement when you lose all your retirement capital, you will not have the time to recover it, he says, and will either have to rely on a state pension - currently R740 a month - or continue working.
So, despite the improved regulation of financial services, the watchwords are still "buyer beware", Stephan says. Do your homework, do not buy anything you do not understand, and do not be pressured into making hasty decisions, he says.
Remaining economically active after retirement is the preferred alternative, Stephan says. If you continue to work after retirement, you can continue to save and can stagger the withdrawals from your retirement capital.
Having an interest after retirement often provides a better quality of life, Stephan says.