The keys to any financial plan.
Saving enough for retirement can seem like a daunting and complex problem. However, there are really only three things that investors have to consider.
“In its simplest form, saving for retirement depends on three factors: time, contributions and returns,” says Adriaan Pask, chief investment officer at PSG Wealth. “Although you can shift your focus between these three factors, you cannot neglect any of them for too long.”
Vitally, investors also need to appreciate how the three factors interact.
“They need to work in conjunction,” argues Pask. “Investors need to understand how they stitch together and appreciate the trade-offs between them.”
Discussions about how best to save for retirement almost always start with giving yourself enough time. That is because the power of compounding over the long term is the greatest tool that any investor has at their disposal.
“Time is really the easiest of the three factors because it doesn’t cost you anything,” says Pask. “The ups and downs of returns have an emotional impact and contributions have a financial impact, whereas time is just being diligent.”
Yet this is something many people struggle with because they don’t realise its significance early enough in their careers.
“It’s not just clients that don’t have a strong income that come to us in their forties and they haven’t saved anything,” Pask says. “It’s often people with a very strong income who just always thought that they would be okay and delayed saving because there were other things that they thought were more important.”
While it’s never too late to start saving, the less time you have, the more difficult it becomes. With a long time horizon, your contributions don’t need to be as high, and you don’t have to take as much investment risk. However, if you have limited time, then you have no choice but to be more aggressive with the other two factors.
“If you start at 45 and want to retire as soon as possible, you have to look at things differently,” Pask explains. “You can’t then invest in a money market fund, because you will never reach your goals. You have to increase your contributions and invest in more volatile, riskier asset classes.”
The second factor is the one that investors have the most control over. It is up to every individual how much they save – and, quite simply, the more you save, the more your wealth will grow.
However, it is crucial for every investor to understand how their level of contributions balances the other two factors.
“A question we are getting a lot at the moment is what do I do when I am getting poor returns,” says Pask. “And the best thing you can do is to up your contributions.”
Saving more means that you can reach your goals even if you receive a lower return. This is not just relevant for times when markets are underperforming, but also if you are the kind of investor who can’t handle too much volatility.
“If you know that you are a conservative type of investor and don’t want to invest too much in equities, then you must make peace with the fact that you will have to make greater contributions,” says Pask. “Similarly, if you are prepared to invest quite aggressively, and you have time on your side, you wouldn’t need to save as much.”
The last of the three factors is the one investors tend to worry about the most – the performance of their portfolios. Ironically, however, it is the one over which they have the least control, since markets are largely unpredictable in the short term.
That doesn’t, however, mean that returns should be left to chance. It is important that investors are in the right mix of products and asset classes to achieve the targets they have set for themselves.
“If your goal is inflation plus 6%, you are going to waste your time in a money market product,” says Pask. “You can’t control the markets, but you can at least control that you are in the right mix of asset classes to get to where you need to be given the time you have left and your contribution sizes.”
The right balance
This is why having a wealth manager is so important.
“A lot of wealth planning revolves around financial coaching, regular mentorship and regular discussions around these three factors,” says Pask. “When you sit with your advisor you have to make sure that you are suited to the kind of investment you have chosen. If you are the sort of person who checks their balance every day and is nervous every time you lose a few rand, then you can’t be fully invested in the stock market. Your advisor should adjust the product mix and recommend that you increase your contributions rather than putting yourself under emotional stress.”
Ultimately it is about understanding how the three factors work together and the trade-offs you can make between them. That is what gives you options to ensure that you reach your goals.
“These are fairly simple calculations that any wealth manager can do, but in the absence of those calculations people aren’t really planning for retirement,” says Pask. “That is why we are finding ourselves in the situation where people are not saving enough.”