Don’t count on winning the lotto to see you through retirement

Opinion piece by Zweli Moyo - Head of Institutional Business at Nedgroup Investments

If you are under the age of 30, retirement may be the last thing on your mind. Unfortunately, unlike the man in Limpopo province who won the Lotto twice, beating the reported one in twenty-four million odds, most of us will have to rely on our retirement savings see us through our golden years.

The earlier we start focusing on these in our working career, the more likely we are to achieve these. Very few South Africans, however, seem to be taking this to heart.

According to a recent study conducted by Old Mutual, which surveyed South African households in the main metropolitan areas working either in the formal or the informal sector, only 12% of Generation Y (people born after 1980) are saving for retirement. Of these, only 28% use pension funds as a savings vehicle.

This is particularly concerning when you consider how much harder it will be to maintain the standard of living you will become accustomed to if you start contributing to a retirement fund when you are 35, rather than 25.

A common measure of how much you will need at retirement is referred to as a net replacement ratio. The net replacement ratio is simply the percentage of income in the year before you retire that you will need to maintain your standard of living when you retire. This is typically about 70%. If you are earning R10 000 per month in the year prior to retirement, to meet a 70% replacement ratio you would need to earn R7 000 per month after retirement.

To illustrate this, assume that, Sipho aged 25 earning R100 000 per year and Tebogo aged 35 earning R150 000 per year, work for the same company. Both join the company on the same day and save 10% of their income each year.

From the table above it is clear that Sipho will retire with more money than Tebogo although he earns less. The real rate of return (ie return above inflation) needed by Tebogo to achieve a 70% replacement ratio is a very high 7.2% [note that over the long term equities, the best performing asset class, has only produced returns between 6-7% above inflation]. Tebogo is in danger of missing his retirement goals as it is unlikely that he will be able to achieve this high real return.

Sipho on the other hand, needs a real return of 4.1%, which should be achievable. By starting to save at a young age, Sipho has improved his retirement prospects. Tebogo could improve his chances of retiring with enough money by increasing how much he saves every year.

While the net replacement ratio may sometimes be a moving target, which changes over time, it is one of the easiest ways to quantify how much you may need to retire and be able to maintain your standard of living.

In conclusion, let us look at a few truths about retirement savings:

• The more you contribute towards your savings the higher the base will be for your investments to grow from.

• The higher the investment growth above inflation the more you will have at retirement.

• Inflation erodes buying power of money over time. It is, therefore, crucial that you always match or beat inflation otherwise you will be able to afford less in retirement.

• The earlier you start saving and the longer you contribute towards your savings, the more you are likely to have in retirement.

• A person who starts saving for their retirement at 40 is unlikely to catch up to the person who starts saving at 30.

• When changing jobs, it is important that you try your best to preserve your savings and not cash in your accumulated benefits.

• Most of us belong to what are known as “defined contribution” funds, which means that we as the members bear the risk of investment growth on our contributions and the company we work for does not. This means that it is critical to keep track of, and to understand, the state of your retirement.

Remember, the earlier you focus on your retirement plans, the more chance you have of achieving your goals.