Retiring With Dignity
08 July 2010
Posted by: Author: Marize Pieters
Retiring With Dignity
The risk of capital loss is a concept that
is, without a doubt, well known and feared by virtually every investor.It
continues to dominate investment decisions and investors seem to be
blissfully unaware of other, equally important, risks involved
in making decisions surrounding their retirement.Another equally
important risk is the danger of not saving enough for retirement.The outcome is that today the majority of retirees unfortunately need to
deal with this harsh reality on a daily basis, when their monthly
income just doesn’t meet their lifestyle requirements.So why does the
notion of losing capital play such a prominent role in the
decision making process of investors, often to the detriment of not meeting
their income needs at retirement?
The concept of behavioural
finance is useful in trying to explain why this occurrence tends to
happen. The powerful force of human emotions often causes investors to go
against good investment practice. In times of market uncertainty,
investors often act irrationally and lose sight of their long-term
They allow the most recent historic events
to dictate their behaviour, leading to a short-term investment focus that
is sure to destroy value.Consequently investors tend to experience
the risk of capital loss as an immediate threat to their savings and a
scenario that could realistically occur today.In trying to minimise
this threat, they often end up being too conservative when making
investment decisions.On the contrary, the realisation of retiring with
inadequate savings will only be evident at retirement. It is not seen as
an immediate threat and takes the focus off meeting their
retirement needs.It is obvious that human emotions can have a
detrimental impact on investors’ retirement goals and should therefore not
be under estimated.Financial intermediaries have a critical role to play
in protecting the client against their own investment
imperfections Retiring with dignity and retaining the client’s focus on
their long term retirement goals.
Let’s consider some of the
imperfections investors need to be protected against and the detrimental
impacts.The first mistake investors tend to make is to postpone saving
for retirement. It is often argued that they are too young to be
thinking about retirement.The need for a car or other consumables are
high on the priority list of purchases when their first few paychecks
or bonuses arrive.Unknowingly they cut down on their investment time
horizon and drastically reduce the probability of meeting their
retirement goals.The effect of compound interest overtime is often
referred to as the eighth wonder of the world and is one of the best
investment tools that should not be overlooked.Investors should be
encouraged to start saving as early as possible, because the longer their
investment time horizon, the better the effect of compound interest and
the probability of meeting their income needs at retirement.
when investors finally start investing for retirement, they tend
to underestimate the portion of their salary that needs to be saved.Investors who start saving in their early 20s need to save between 13%and
20% of their salary if they want to retire at 55 as opposed to 44% and
70% if they start saving at only 40 or 45.The longer investors wait to
save for retirement, the higher the portion of their salary they will have
to contribute to give them any chance of retiring with dignity at 55.
investors tend to be too conservative and invest for retirement without
holding sufficient or any inflation-beating (real) assets.Statistics from
ASISA confirm the conservative nature of the South African investor.The retail market composition indicates that 32% of retail investors are
currently invested in money market funds.History shows us that this
portion remains high and tends to fluctuate around 30%.These
investors seem to be comforted by the fact that the probability of losing
their capital is virtually zero, but are seemingly unaware that their investments rarely beat inflation.
picture looks even worse on an after tax basis.Another market, dominated
by extremely conservative investors, is in our neighbouring country
Namibia.Surprisingly,nearly 85% of Namibian investors are invested
in money market-type funds with this phenomenon being evident for
quite some time.Even though the tax structure on interest is more
favourable in Namibia,there is still an enormous task that awaits the
Namibian financial intermediary,in terms of educating investors on
the devastating effects of retirement savings not beating inflation.
is it so important to beat inflation? The main reason is that inflation
causes money to lose its purchasing power. In simple terms,try to
remember what a loaf of bread or newspaper cost a few years ago versus
what it costs today or maybe how much house or car prices increased over
the years.Given this, it is essential that retirement savings beat
inflation over time.If investors are not able to achieve this, they will
have to downsize their lifestyles to enable them to live off their
retirement savings.This harsh reality surprises many retirees today
and shatters their dream of retiring with dignity after a lifetime of hard
Table 1: Annualised from 31 March 1967 to 31 January 2010
Source: Glacier Research (Note: JSE returns excl. dividends)
Consequently it is vital to hold real assets in your portfolio.Equities are by far the best performing asset class over the long term and the best inflation-beating asset (positive real returns) to hold.However, short-term performance can be extremely volatile at times (see table 1).Despite this, studies have shown that equity returns become rather predictable over time, as is evident from the graph below where the average annualised return over the last 20–30 years was close to 20%.In essence, if an investor has a reasonable time horizon ahead of him, he can actually not afford to exclude equities from his portfolio.
It is clear that investors need to hold real assets to give them any chance of meeting their retirement needs.However, increasing the exposure towards real assets in a portfolio will increase the risk of such a portfolio.Conservative investors should definitely not be discouraged and think that their default optionis cash only.They should understand that it’s imperative to maintain a good balance between their psychological risk profile and their needs for retirement when making investment decisions.The limited risk they are willing to take on, in line with their psychological risk profile, makes it a challenge to beat inflation in the long run.There are excellent fund managers in the flexible categories that have proven their ability to protect capital in market downturns while still managing to deliver in flation-beating returns over the longer term.Managers with the ability to successfully move between asset classes in different and difficult market conditions are, however, scarce and careful consideration should be given when picking these funds.
Finally, as investors reach retirement it is essential that the investment process does not end here.The biggest mistake investors tend to make is to move all their saving into cash the moment they retire to entirely reduce investment risk.Many investors are unaware of the detrimental effects of moving too conservatively too quickly.It can mean the difference between retiring comfortably versus the harsh reality of depleting one’s capital.Due to improvements in medical technology, people tend to live longer and retirees need an income that will last another 20–30 years, on average, after retirement.
This is a very long time in investment terms.It is therefore crucial to grow one’s asset base above inflation for a few more years after retirement at levels of risk that are more appropriate for a client drawing an income.The graph below indicates that a client’s capital can last an additional eight years by investing in funds that deliver returns off our% above inflation while drawing a reasonable income.
Financial intermediaries have a pivotal role to play in guiding investors to successfully plan for and retire with dignity.The intermediary is that person who is willing to walk along side his client every step of the way; someone who the client can trust and who is the first one to protect the client against himself when the road gets rocky or uncertain.While proper communication is critical to clarify retirement goals and impart knowledge, more important considerations are all the relevant risks (referred to in this article) which should be taken into account.
Everyone wants to retire with dignity,especially after having worked a lifetime for one’s hard-earned cash.The reality is that very few people are able to get it right and unfortunately there is no second chance.
Source: By Marize Pieters (TaxTALK)