Live Long – Die Poor

Retirement revisited

One of the conundrums of modern life is that we live longer due to better lifestyles, medical advancements etc. This is almost universally celebrated – we all enjoy the prospect of being around to see our children, grandchildren and great grandchildren grow up and be around for their milestones. There can be no better retirement than enjoying life after the years of hard work.

People retiring today are not living 10-15 years after retirement but more like 20-25 or more. The problem is that wealth advice, on the whole, has not kept up with these radical changes in assumptions on longevity. In the mid noughties when I came into this industry, advisors were taught to project retirement savings income out 20 years and that capital exhaustion was acceptable. There are still parts of the insurance investment industry where this still takes place. There are also advisors who will advise that a silo approach to onshore and offshore investments be used, and that depletion of local investments is not just prudent, but advisable – because “we all know offshore will more than make up for any capital withdrawals locally”… I wish! Why on earth would a broker/advisor even buy into these ludicrous practices? Let’s look at some of the background and assumptions.

Every year we get a greater understanding of what shortens life, but this is increase in life expectancy has to be funded. In countries that have decent government sponsored pensions this is causing a severe problem, exacerbated by the slowing birth rate. In effect, in those countries, they are using pension contributions from the young to pay the old, and estimates made decades ago as to how long people would live in retirement are now way out. This is all going to implode one day. The dramatic wobble in UK pensions during the Truss debacle is a small foretaste of what is to come. By 2030, the last of the Boomers will stop contributing to pensions and start expecting a pension. The following generations have a lower birth-rate and are nowhere near the wealth level of their Boomer parents at the same age.

In South African we do not have a meaningful government pension scheme to fall back on, just our own investments accrued over time either in a retirement wrapper or discretionary assets.
You now also have to assume that you will live at least 30 years past retirement. So how do you fix this?
For salary earners there are very few options. You have to save and invest more. Most salary earners in decent sized companies must contribute to a provident fund, and over a working lifetime should solve the problem. Mmmm. Not so fast. People now change jobs on average every 3-5 years, and 90% of them will cash-in their provident/pension fund. Making that up later, when the kids have left school, the bond is paid off etc isn’t as easy as you think – but also not impossible.

Here are some pointers:

  1. Put a date on your retirement, this helps you and your planner determine how you need to build your wealth towards that date… a goal if you will. It is just not realistic to expect someone to put the same amount (as a percentage of their salaries) away all of their life, because there are times when there will be less disposable income than others. There will be times when you can accumulate more – if you’re disciplined enough to do so. This is one of the most useful roles of a Financial Planner – helping you divert wealth and invest it, before it burns a hole in your pocket. Even if you never want to retire – quite possible if you’re an entrepreneur – you still need this retirement pot in case your body or mind packs up. It happens.
  2. Have an idea, in today’s terms, how much you’d need as an income from your investments. A Financial Planner can work out the size of capital to produce that, what growth and inflation might be etc, but they cannot tell you what that income should be. To do this properly you’ll have to do a personal income statement (aka a budget). Medical inflation runs at 4% or so above ordinary inflation, so the planner needs to consider this when planning for your future income. Once the planner has set out how to achieve your end objective, it is a journey to get there. Life happens, Recessions happen, jobs are lost, children fail to launch out of the nest. Build a relationship with someone who can keep you on the road and out of the donga.
  3. Pre and post retirement investments should be treated quite differently. Pre-retirement funds, especially those more than 10 years away from retirement, should be exposed for maximum growth, local and offshore. This doesn’t mean that you throw everything into a high growth portfolio and come back when you need it, but it also doesn’t mean that the portfolio needs micromanagement either. From 3 years out from retirement the portfolios need to start aligning themselves with their new job – to produce an income. This requires quite a different portfolio compared to a growth portfolio – and more skill and experience in a diversity of asset classes. If you have built up a critical mass – say over R8m in investments – then you can bring down costs by using a bespoke asset manager (who manages diversified asset portfolios, not just stocks, locally and offshore). Unit Trusts were designed for smaller or growing portfolios, but these should also change when portfolios switch from growth to income. You can keep costs down by using ETFs and Trackers, and most Independent Financial Planners have access to these tools too.
  4. As you get older your appetite for risky investments, and the personal management thereof usually diminishes. If, at the retirement phase you still want to keep your hand in, then hive off the assets needed to produce your sustainable income, ring-fence and let someone manage that – and use the excess to play with. It should be money you can afford to lose (but please don’t go and leverage it too). Managing income producing assets is a multidisciplinary approach that requires the blending of asset classes like fixed and variable income bonds, REITs, high dividend stocks etc and is beyond the experience of most stockbrokers let alone retail investors managing their own portfolio.
  5. Income producing investments usually come in the shape of bonds, with a smattering of dividends and REITs at various times and with a growth component from stocks to ensure the capital grows and therefore sustains the income in line with inflation. It is possible to just have a stock portfolio and use dividends, but then the sustainable income should be reduced in line with the dividend profile of the underlying companies. Remember to review this once-a-year to determine how much more can be extracted (if any) and still keep the investment sustainable without capital erosion. This approach of course immediately takes certainty out of the equation.
  6. Prudence. There is no getting around it, if you want your investments to produce an income indefinitely, increasing with inflation and without any volatility, then you have to manage it prudently. This prudence takes several forms.
    a. The drawdown shouldn’t exceed 5% per annum, 4.5% or less is even better.
    b. All the liquid assets, local and offshore should be considered and managed together.
    c. Residential property should not be considered as an investment asset – it just replaces rental expenses. Other illiquid assets can be built into the plan at a later date, if the pressure on the investments are too high.
    d. Capital depletion of any asset bucket, local or offshore should be avoided at all costs. In RSA Inc, some brokers advise that clients deplete local investments, saving offshore for later – this is a recipe for disaster (but the errant broker will be long gone before the flack hits the fan). It is much better to take a prudent drawdown from all your buckets of investments, including offshore, and bring the offshore income back once a year – and timing that according to the exchange rate. How and when this is done is the role of an experienced Financial Planner and should take into consideration the investor’s assets which are almost always unique. Roboadvisors, the Twitterverse or Cookie cutter programs used by brokers cannot give you this sort of advice.
    e. Offshore investments have the added complication of the exchange rate fluctuations which adds a whole new layer of uncertainty that must be planned for.
    f. It is very difficult to accept a smaller income than you want, need or are used to at retirement. Who wants to to be forced to scale back after decades of hard graft? Brokers will ultimately bow to your wishes and give you the income you want, knowing that they will be long gone when the investment depletes. Find a Trusted Planner who will work with you over the years to align your wealth with your dreams, help you make the uncomfortable choices before its too late, look after your investments prudently and holistically, and not leave you with a nightmare in your final years.
  7. Your pre-retirement sources of income. Not everyone can work for themselves but prefer a corporate environment. Notwithstanding this, working for yourself is becoming easier all the time and has the added benefit that a corporate can no longer dictate your sell-by-date. Working for oneself can take the form of contracting or freelancing and as long as your skill set is maintained, can last as long as you would want. Having your own property portfolio used to be the great panacea of having a passive income at retirement, and in many ways it still is, but it isn’t really passive at all. The property has to be maintained, tenants managed, utilities paid, insurance paid and defaulting tenants evicted (with legal fees). To add insult to injury the return on Investment isn’t great. Ordinary investments like stocks or ETFs, properly invested, are actually far more passive. They can be managed from your armchair, without the risk of defaulting tenants. Capital appreciation of property has been stagnant for years – you might as well have owned stocks, and taken dividends.

In summary then, if you want to fund your long healthy life, then the assumptions made a decade or more ago are going to have to change. The good news is that change that is implemented slowly is much less painful than those imposed quickly, and doesn’t necessarily end up with a slow boiled frog.