The price of being too conservative

Henry van Deventer, financial planning coach at acsis

While the volatile markets that characterised most of 2011 are most likely to continue into this year, retirement fund investors should be wary of opting for the ‘safe’, cash investment options, as this is often one of the greatest mistakes investors make

Henry van Deventer, financial planning coach at acsis says that the closer investors get to retirement, the more stressful the decision becomes because the consequences of making the ‘wrong’ decision could seriously affect their quality of life in retirement. “Because of this concern, the natural instinct before retirement is to put money where it is ‘safe’. This often means a more conservative investment strategy, and in most cases, it entails being heavily invested in cash. The reasoning is that if the market falls during the year that an individual retires, he or she should be safe. If it does not, the individual will still be able to sleep at night.”

Van Deventer says that this mistake is often made by investors who do not understand what they are potentially sacrificing by seeking safety in cash. “As a starting point, consider that, as a rule of thumb, investors can draw a monthly income of about R5 000 before tax for every million rand invested at retirement. They therefore need to give themselves the best possible chance to accumulate as much as possible before retirement with as much certainty as possible. The five years prior to retirement are especially crucial in achieving this.”

He says that investors need to know how to grow their funds before retirement age and what to expect. “For the best possible growth, investors should mainly be exposed to shares. Between 1925 and 2011, the average annual return on South African shares was approximately 14.4%. This means that a responsibly managed, share-focused strategy would have doubled roughly every five years. In cash, over the same period, the average return was approximately 6.7% per annum.

“Therefore, by applying the above, investors with R1 million five years before retirement, a share portfolio could, on average, result in about R1.96m at retirement. A cash portfolio on the other hand could result in just over R1.38m – about two-thirds less. In terms of difference to monthly standard of living, a share portfolio would have produced about R3 000 more per month. If we apply the same argument to ten years before retirement instead of five, the difference becomes quite staggering - an additional R10 000 per month.”

Van Deventer says that one concern with the above argument is that share market returns are not guaranteed. “Investors will most probably lose some money during one of the five years before retirement as historically, South African shares produce a negative return 32% of the time, or roughly once every three years. However, over a five-year period, they have a 95% chance of achieving a positive return.

“Over longer terms, chances of a positive return become even better. By investing in a responsibly managed and diversified share portfolio, the chances of getting a high positive return become better yet. We also need to remember that the investment term does not stop when one retires. It stops when the investors stops – which should be more than 25 years after retirement age.

He says that investors should consider that the more time they have available and the more responsible they are by not gambling on the share market (it is best to stick to a fund that will consistently follow the markets), the less the risk becomes and the better their retirement lifestyles could be. “However, investors need to remember that an objective, expert financial planner needs to play a vital role this regard. Do not be afraid to pay a fee to get sound advice – it may well turn out to be the most valuable item ever bought,” concludes Van Deventer.