| The years in the run-up to retirement, probably from the age of 55, are probably going to be the most important in terms of what your eventual retirement looks like. You at least have some wiggle room to improve the outcome. It’s also the time to do some serious adulting – risk and gambling have no room anymore in your investments, it’s not cool to be clueless, and it’s very dangerous to abdicate the responsibility to a spouse or partner who enjoys and understands this stuff better than you do. Retirement is an event, not a date, and it can also be an event that you ‘ease into’ aka semi-retirement – but what ever route you decide to take, the sooner you start thinking about it (even if you and your planner look at different scenarios) the better the chance you have of influencing the vision of what your retirement is going to look like. As much as you may have avoided it in the past, you are going to have to get professional help. A once-off retirement plan is not going to help, this is a journey, pre- and-post-retirement, find a planner/advisor who is experienced in retirement planning and is prepared to help you walk that road.  Your retirement pot is probably going to one of the biggest investment pots you have built to date and from age 55 it’s probably time to consolidate them. Why age 55? That is the magic ‘retirement age’ set out in the pension funds act (among others) where the better tax dispensation kicks in if you want to ‘retire from’ your formal pension investments. You’ll notice the deliberate use of the phrase ‘retire from’ because it has nothing to do with actually retiring from your ‘active income’. Pensions, by their sheer definition are ‘passive’ income streams. I have found over the years that clients by the time they reach this age, inevitably have investments dotted all over the place, and part of our job it to consolidate these and find a single coherent objective, so that the desired outcome – a sustainable income that meets expectations – can be achieved.  In our profession we call these crucial pre-retirement years the ‘accumulation phase’. Usually this is the time of life where mortgages are paid off, debt is way down, if not paid off, children are on their way to leaving the nest and unless you’ve allowed ‘life-style creep’ to eat up your spare discretionary income, there should be more available to invest. There are two hard variables that you need to wrap your head around when it comes to planning for retirement – and if you’re 10 years away from retirement you still have the privilege of working with those variables and more. * Firstly you need to know (in present value terms – let your planner do the math) how much monthly income you want/need in retirement. * Secondly your need to put some thought into that retirement event date (this gives you and your planner an idea of how many years you have to implement this plan).  Even at this very basic level, a planner is going to be able to tell you what sort of income you can expect if you maintain the ‘status quo’. For both you and your planner’s sanity sake it’s important to be clear on the expectations and outcomes at least ten years out from retirement. I can tell you from years of experience is that if this conversation is held at the retirement event, a client’s expectations are rarely met! That is not to say that if you shop around you aren’t going to find a broker that will tell you the words you want to hear by promising you the income you desire. In terms of the pensions fund act, you can draw down on your formal pension investments between 2.5% and 17,5% per annum – but the prudent rate that will give you a sustainable income growing with inflation, whether you live to be 66 or 106 years old is both dependent on market conditions and ensuring that a reasonable income is taken. What that broker isn’t telling you is that at 17,5% per annum that income is going to last 6-7 years, declining every year until it falls below the minimum and you can cash in the last bit (by which time he will be long gone). If you leave your financial affairs too late all your planner is going to have to work with is what you’ve got, and you’re going to have to live with the income that comes out of it (and believe me, it’s never as much as you think it is).  When you have a few years to work on your retirement pot, your planner can be more creative with how those funds are invested. They can take advantage of higher growth and offshore stocks that might have more volatility in the short term but this evens itself out over time. When retirement is imminent however, the planner and asset manager will have far fewer investment choices to invest your pot in to secure you a stable income that grows with inflation and lasts as long as you do. From your required income at retirement, it is quite easy for a planner to determine how big your investment pot should be, and there are calculators on the web that will do it for you, but there are a couple of other variables you will need: * Annual drawdown on the capital – in other words the income you will need. This will vary depending on the prevailing interest rates, but in South Africa the maximum prudent amount is 5% per annum. But remember that this is a dynamic number. What is right for one individual at age 65 may be completely wrong for another at the same age. Also, this number can shift with age but understanding it’s capital affects should be the cornerstone of financial planning. * You need to make an assumption on the growth rate of stocks and inflation. * The third variable is not used by all planners and advisors – but it is crucial to my investment philosophy in the immediate run up to retirement (say 18 months or so out). That is the yield of the investment – or in other words all the income the portfolio will generate over the course of a year as a percentage of the portfolio value. Obviously, in order to make assumptions on these variables you need to have a pretty good understanding of investments and keep close to the market on a daily basis. Knowing how big that retirement pot should be is only one part of the equation, the planner needs to draw up a plan with you on how to get there.  The difference between growth and interest Please excuse me if I am keeping it too basic here – but I come across the confusion between interest and growth every day with my clients. Let’s keep it to the RSA discussion (where interest rates are much higher than the UK or US for example). You might be thinking that you can easily get 5% – 7% or more annual interest from a fixed deposit – and you can even guarantee that rate of interest when fixed rate bonds are bought. However, unless you plow back some of the interest, the price you paid for the bond is slowly going to be reducing in real terms as fixed income is not a good inflation hedge. This is why owning equities in a portfolio is so important. They protect the portfolio against inflation creep as equities grow in real terms over long periods of time. The balance between the various asset classes is what is important though and what a financial plaaning process should be pointing out. When we design income generating portfolios for our retirement clients, the yield – from ALL the various sources, is the backbone to the retirement income investment. Consolidation of your investment portfolios (which can be done with all formal retirement funds without interrupting their tax status) often brings the investment up to a ‘critical mass’ which allows your advisor and asset manager to bring down costs and tailor make your portfolio. Your retirement pot need not all be investable income and can include properties from which you get rent (but this isn’t the pot of gold it was promised a few decades ago). I often get clients adding in the value of their residential property to their retirement pot, usually based on misconceptions of ‘downsizing’. The ugly truth is that the cost of housing in a retirement village is probably going to be very close to what you sell your property for net of the costs (and then there are the ever-increasing levies, frail care cost etc).  Importance of asset allocation For most people, their retirement savings are usually their single biggest asset, by the time they get to retirement it probably eclipses your house value. The good news here is that the sheer ‘critical mass’ of the investment makes it much easier for a planner and asset manager to tailor-make a lower cost solution for you than just throwing it into a bunch of well-known unit trusts and hoping for the best. Most of the clients in my practice are over the age of 55 – so we have seen from experience what works and what doesn’t. The investment philosophy that the planner and asset manager will use to invest your funds at retirement to ensure that you get the income you need is crucial. This is not an airy-fairy mission statement found on a slick webpage of a financial institution – it is going to make a huge difference to your retirement outcome and whether your income is going to run out before you do. The prevailing ‘wisdom’ when I came into this profession was that retirement income should last 20 years, and the principle of capital depletion over that time was used (in other words your capital ran out in 20 years). This approach pleased clients no end, because it gave the illusion that they were getting more bang for their buck, and on a couple of occasions we found clients shopping around for the highest income -without understanding the long-term implications. One of the reasons I like to work with clients over a long period of time is so that I can manage their expectations and dispel some of those dated ideas before crunch time. Even today I find that some brokers are happy to use this ‘capital depletion’ method of income generation – knowing that the chances of any comeback from a client in 20 years is remote. I always had a huge problem with that approach. I never wanted to sit in front of a client, now probably well into their 80s, and explain this to them.. “Remember when we had that discussion 20 years ago and I told you that this money was going to run out in 20 years and you said it was fine, nobody in your family lived into their 80s anyway? Well…” Today, I would rather walk away from a client who insists on capital depletion, knowing that there are plenty of brokers out there who will gladly do as their asked and not care about the consequences (as long as they get their commission).  I have a very different retirement investment philosophy to the old capital depletion model, I believe that the income produced by the retirement investment should be: Certain (not fluctuate – with the normal trend of the equity markets)), Grow with inflation, Never run out and, if possible, have some wriggle room for ad-hoc expenses. I will go into this in more detail in my next post, but if you’d like to get our weekly newsletter, heads up on our new posts and podcasts or just ask a question by dropping me an email. Articles and Blogs: Wealth creation is a balancing act over time NEW Wealth traps waiting for unsuspecting entrepreneurs Two Pot pension system demystified Keeping your legacy shining bright Financial well-being when dealing with Dementia and Alzheimers Weathering the storm Pruning your wealth farm Should you change your investments with changing politics? Taking a holistic view of your wealth Why do I need a financial advisor? Costs Fees and Commissions The NHI and what to do about it New-Normal for Retirement? Locking-In Interest rates – The inflation story Situs – The Myths and Reality Tax Residency – New Rules new headaches Are retirement annuities dead A new look at retirement Offshore investing – an unpopular opinion Cobie Legrange and Dawn Ridler, Rexsolom Invest, Licensed FSP 45521. Email: cobie@rexsolom.co.za, dawn@rexsolom.co.za Website: rexsolom.co.za, wealthecology.co.za |