Make your money work
For those of us who have the luxury of being able to play the markets with our spare cash in the hope of building up additional wealth, the current economic environment has been somewhat traumatic. This however pales in comparison to the anguish being experienced by those individuals who after many years of work have now settled down into retirement with the hope that their invested retirement savings will see them through the balance of their lives at a requisite level of comfort. It’s easy for investment professionals to preach the demerits of market timing, but it’s not that easy as a retired investor to sit back and watch the capital value of one’s life savings suffer capital depreciation as equities buckle under pressure from the current dire economic circumstances. Pre-retirement investments are typically balanced funds. Since the onset of the downturn the average balanced fund experienced a capital drawdown of approximately 19%.
Despite the fact that the current global recession has been unprecedented in many ways, it does help to cast our mind’s eye back to what has been a consistent truth across the past eight recessions experienced in South Africa since 1960. In so doing it becomes clear that even though previous recessions have varied in severity from -22% to -62% and lasted between 4 to 29 months, all of them have recovered dramatically and posted impressive gains within as little as 3 months. Another important consideration which investors need to bear in mind is that markets and the economy do not move perfectly in tandem with each other. Markets are typically forward looking, meaning that market recovery usually precedes a visible recovery in the economy. What this means is that it is not only incredibly difficult to time the market, but that it is particularly difficult to time the market by looking at what is happening in the economy!
This inability to time the market, coupled with the understandable desperation of investors typically sees them cashing in undervalued assets at market lows after already having incurred capital losses. When the market does recover “unexpectedly”, which it always does, investors scramble to get back into the market, but typically miss a significant portion of the rally. This double whammy results in a situation in which investors break the cardinal rule of investing by selling low and buying high.
The main difference between investing for retirement and investing during retirement is the need to provide for an income, which in effect is the constant reduction in the capital base of an investment. Returns on a post-retirement portfolio therefore need to be consistent enough to provide relative stability of capital while covering the income withdrawals. Once retired, retirees have the option to commit their retirement funds to two types of investment vehicles – a traditional life annuity or an investment-linked living annuity (ILLA). A traditional life annuity is a lifelong policy that pays a guaranteed income based on the amount invested. Investors can choose an income that increases to offset the damaging effect of inflation on one’s purchasing power (and standard of living) although this option requires a higher initial outlay. Once this option is chosen, retirees only have to ensure that the income payments are sufficient to cover the living costs for the remainder of their lives. In effect, the investment risk is transferred to the company offering the policy. With the increasingly popular investment-linked living annuity, the risk of the investment not meeting the retiree’s requirements remains with the investor. This makes the pre- and post retirement decision even more onerous as one has to consider growing capital to beat inflation, while drawing sufficient income to maintain one’s standard of living.
Investors often ignore the effects of inflation on purchasing power after retirement as inflation has a reduced effect while one is working and salaries are increasing. It is only after retirement that the effect of inflation needs to be offset by investing in assets that have the ability to generate returns in excess of inflation over time. While a typical balanced fund may be too risky for some retired individuals, to ensure that investors enjoy a relaxing and fruitful retirement, a post-retirement portfolio must be structured to at least meet income needs and beat inflation. Investors approaching retirement should consider their level of savings and potential income needs to determine the optimal retirement portfolio. The transition from pre- to post-retirement in most cases where risk tolerance is limited should be a gradual de-risking of the portfolio (e.g. from a typical balanced fund to a lower-risk absolute return portfolio) as opposed to a knee-jerk reaction to the current market conditions. This ensures that the retirement plan is sound and that investor’s emotions are removed from the retirement planning process.
