JOHANNESBURG – Planning for retirement is an integral part of any individual’s long-term investment strategy, but this does not mean that planning and managing a portfolio should stop at 65.
While there are a considerable number of issues retirees should take into account to ensure that they don’t outlive their capital, this article will focus on three that were raised at a retirement seminar this week.
Keep in mind that the list is not exhaustive and that individual circumstances should be taken into account when making investment decisions.
1. Manage volatility risk
Peter Nieuwoudt, executive director of The Wealth Corporation and former chairperson of the Financial Planning Institute, emphasised the importance of managing volatility risk in retirement, by outlining three different scenarios where an investor achieved an average compound return of 7% per annum over a 20-year period.
In the first scenario, the return was identical each year ie, 7% per year. In the second, the average return was still 7% per annum, but higher returns were predominantly achieved in the early part of the investment period. In the third scenario, the returns were relatively poor in the first part of the investment period, but recovered later on. Yet, the average was still 7%.
Nieuwoudt said if an amount of R1 million was invested at the beginning of the period, the investor would have about four times his initial capital at the end of the investment period in all the scenarios, as long as he did not draw capital from the portfolio at any point.
But if the same scenarios were repeated with a drawdown of 5% per annum (a typical retirement scenario), the result is completely different. In the first scenario, the investor would have R1.68 million at the end of the 20-year period, in the second R2.47 million, but would have nothing left in the final scenario.
This simple analogy highlights how vastly different planning in retirement is to planning for retirement.
“Your financial advisor has to manage volatility risk when you retire.”
Nieuwoudt said it is important to monitor how much capital the retiree has left on an annual basis, how the investment performed in relation to the planning assumptions and to vary the drawdown rate against this background.
If the investment exceeded the planning assumptions the drawdown can be increased, but if it hasn’t it has to be reduced.
2. Don’t be ‘recklessly conservative’
Nieuwoudt said many investors have been advised to use a “life stages” approach to financial planning.
This means that their investments should become increasingly cautious as they get closer to retirement, with all of the retirement savings in cash shortly before they retire.
He said the fallacy in this logic is that for many people there is a lot of life left after retirement. Some people may live another 40 years after they retire and when compound interest, the so-called eighth wonder of the world, was working at its greatest, and investors had the largest amount of capital at their disposal, they switched to a more cautious investment.
The figure below highlights the potential impact of the life stages model (the red line).
Source: The Wealth Corporation
Investors should consider that inflation is the enemy.
“If you are investing for the long-term you have to have growth assets. You cannot have cautious assets or fixed deposits or money under your mattress if you are in it for the long haul,” he said.
For those who retire at 60 or 65 there generally is a very long period ahead. Traditionally they plan for clients to reach 95 years, he said.
Nieuwoudt said any advisor worth his salt will structure a retirement portfolio in such a way that the investor draws an income from a low risk fund and secure the capital growth from a higher risk or a higher return fund.
3. Exercise financial discipline
It is important to consider that passive income does not provide windfalls, Nieuwoudt said.
Prior to retirement many investors aren’t disciplined in their budgeting and incur debt, but settle it when they get a bonus or windfall.
“When you are living off capital it is not possible to do that.”
Retirees therefore have to be extraordinarily disciplined.
Nieuwoudt said the assumptions used to draw up a financial plan are vital. If the retiree wants to go overseas every two years, the cash flow implications have to be incorporated in the budget.
While a number of retirees are also looking after their parents financially and/or supporting children, it is important for investors to ensure that they have enough for their own needs before they start supporting others.
Investors should also consider the difference between wealth and affluence. Wealth is the ability to live within one’s means. A show of affluence – spending more than you have – is not true wealth.
Nieuwoudt said the Scottish produce more millionaires than others because they are by nature very frugal people.
Retirees should also refrain from investing in lifestyle assets (second homes, renovations, holiday cottages etc.) unnecessarily.
These assets come back to bite you, he said.
“Unlike an investment asset, a lifestyle asset is a consumer of cash, not a generator of cash.”
Author: Ingé Lamprecht