There are many risks that need to be overcome to ensure that retirement savings last, says Shaun Duddy, including longevity, inflation and investment risk. In the piece below Duddy debunks common myths associated with retirement savings.
Myth #1: My savings will outlive me
The simple truth is that many people will live a lot longer than they expect. Based on our current understanding of South African mortality statistics, around 30% of women who retire at age 65 will still be alive at the age of 90.
This is a sobering reality for investors who think that their savings will last beyond their living years.
Myth #2: I only need to account for 6% inflation in my savings plan
Although inflation has averaged about 6% over the past 10 years thanks to the inflation-targeting efforts of the Reserve Bank, there have also been times, for example in the 1980s, when inflation has spiked to 20.
Even at 6%, inflation can have a big impact on your standard of living: Over 30 years, the buying power of R1 000 would be eroded to the point that it only buys goods now costing less than R200, at an inflation rate of 6%.
Investors who are ready to hang up their work boots to ensure that they account for inflation in their retirement planning, as inflation has a very real impact on the purchasing power of their income.
Many of the guaranteed annuities sold in SA today do not have inflation-related increases built into them; a sobering reality.
Myth #3: I can draw down more than 4% of capital
A starting income of 6% of capital may not seem like a lot, but once you account for the fact that that income needs to keep up with inflation for say 30 years, the minimum real (after inflation) return required to ensure income sustainability is 5.5% per annum.
The chances of achieving this level of return are quite a lot lower than you would think. Looking back at very long-term asset class returns doesn’t give a full perspective. While the average return that is likely to be generated by your portfolio over time is important, it is also very important to understand what your personal return experience in that portfolio is likely to be: the ordering of your returns, volatility and the timing of your withdrawals all influence your personal return outcome and therefore the sustainability of your income.
The reality is that if you start income drawdowns at more than 4% of your capital, the odds of sustainability are not in your favour.
Myth #4: I can’t afford to take risks
Don’t be too conservative when it comes to investing your retirement savings.
Our research suggests that you need a well-diversified portfolio with at least 50 to 60% invested in growth assets, such as shares. This may mean you have to stomach some short-term volatility, but if you invest only 30% in equity, it’s unlikely that your retirement savings will last the distance.
Three tips to help you achieve a sustainable retirement income
- Calculate 4% of your capital value as a maximum starting income for the year
- Increase the resultant rand value only by inflation every year
- Invest at least 50 to 60% of your portfolio in equities for growth
If you follow this strategy, there is a strong likelihood that your income will last for at least 30 years.