Getting a jump start on a successful retirement
Financial advisers and planners have a crucial role to play in ensuring that their clients remain on track with their life financial plans. The disruption caused by the pandemic and subsequent national lockdown has resulted in many individuals deferring important financial decisions or ‘waiting out the storm’ in risk- and outcome-inappropriate assets. As the world enters the next stage of its post-pandemic economic recovery you should be encouraging your clients to revisit their financial plans and make sure that they are still on track to achieve the financial goals and objectives it contains, especially that of a sustainable retirement.
Consistent and timely retirement planning
There are plenty of ‘hooks’ you can use to refocus your clients on the need for consistent and timely retirement planning. An Alexander Forbes media release titled How to prepare for and take control of your retirement encourages consumers to begin saving for their retirement as early as possible. “Too often, people only start to think about their retirement when they are five or 10 years away from it,” says Rita Cool, a Certified Financial Planner ® at the financial services firm. This is way too late. It makes more sense for individuals “to get the ball rolling as soon as they start working”.
Many of our readers are probably sick to death of the oft-repeated formula for a successful retirement; but we will repeat it anyway. To ensure a sustainable income in retirement requires that you save 15% or more of your gross annual income for 40 or more years, and always preserve. This recipe for success comes courtesy the retirement funding industry and has been repeated ad nauseum at retirement funding events and seminars for decades. Yes, it is simplistic. And yes, it fails to acknowledge that there are many paths that can lead to a successful retirement. But it hits the mark in putting the spotlight on time as one of the biggest value generators in the savings environment. Time is also recognised as a critical factor in building wealth.
Small, incremental steps to accumulate wealth
An Actuarial Society of South Africa (ASSA) article titled How to grow a meaningful nest egg with little money but a lot of time perfectly illustrates this point. Darius van der Walt, actuary and member of the Investments Committee of ASSA, warns against the misconception that building wealth requires a sizeable amount of money. “While you need some spare cash in order to invest, having a lot of time ahead of you is far more important than the amount of money you can spare every month,” he says. “The earlier in life you start investing, even if it is a small amount, the bigger your nest egg will be when you need it most”.
Thus starts the discussion of the magic of compounding, a familiar story to regular FAnews readers and financial advisers worldwide. Investopedia.com offers a succinct definition of compounding as “the ability of a sum of money to grow exponentially over time by the repeated addition of earnings to the principal invested; each round of earnings adds to the principal that yields the next round of earnings”. In this context ‘earnings’ refer to the dividends, interest or rental income earned on an initial capital investment. “It is the compounding effect, over time, that significantly accelerates the growth of your clients’ investments,” explains Van der Walt, who offers the following example to illustrate.
Two of your clients invest monthly amounts into a portfolio of unit trusts in the South African Multi Asset High Equity category; but the timing and amount of their instalments differ. Unit trusts in this category are designed to earn both dividends and interest in addition to capital growth and are suitable for investors with longer term investment horizons. For the purposes of this example, we assume that each client starts their journey at the same time, age 25, and earn the average return, net of fees, on the aforementioned unity trust category.
Helping R60k to punch above its weight class
Client A starts saving in February 2001, at age 25, by investing R500 a month in a SA Multi Asset High Equity portfolio. Over the next 10 years client A invests a total of R60 000, reinvesting all earnings. Monthly contributions stop at this point; but client A chooses not to withdraw any of the investment, leaving it to grow until the end of February 2021. Client B chooses to party from age 25 to 35 and only starts contributing to a SA Multi Asset High Equity portfolio from February 2011. In an attempt to make up lost ground, Client B decides to invest R1 000 per month into the fund, contributing R120 000 over the following decade. Once again, all earnings are reinvested.
At the end of February 2021, client A’s investment would have been worth R265 782. And Client B would be sitting on a disappointing R174 290 despite having invested twice as much capital. And that, dear readers, is the power of compounding, sweetened by time. Client A’s investment benefits from an additional decade of compound growth. The example was reworked to illustrate how compounding benefits an investor in a less volatile SA Interest Bearing Money Market portfolio. In this case Client A’s R60 000 investment would have been worth R174 021 and Client B’s R120 000 investment would have been worth R168 078.
Time in the market is an obvious winner for retirement savings outcomes and explains why retirement fund managers encourage your clients to begin saving for retirement as soon as they start working. As a financial adviser you will be painfully aware of how difficult it is for late starters to make up this lost ground, a reality that makes managing client expectations through the retirement savings process all the more important. Van der Walt also concedes that it can be tough for your clients to think about long-term investing when their current focus is on keeping a roof over their heads and food on the table.
The ABCs of sound household finances
Cool observes that something as simple as a household budget could get your clients thinking more urgently about their financial goals. It is not adequate to simply match income and expenses; each expense should be carefully considered to eliminate waste and free up money for different savings objectives. Your clients should then review progress against their budgets on a monthly basis. “By starting this good habit, your clients will be using the opportunity to put themselves in a better position to achieve [positive financial outcomes],” she says.
Van der Walt offers two anecdotes that should resonate with late starters. The first is that the best time to start investing / saving is today, and the second is that starting small beats not starting at all. “The reality is that there will likely never be a comfortable time to start investing,” says Van der Walt. “But the discipline of committing a fixed amount every month to a long-term investment will secure a better financial situation for your clients and their families in the future”. South Africa’s collective investment schemes (CIS) industry is the perfect playground to practice investing and savings discipline with many funds taking minimum monthly investments of just R500. Those who can afford to should increase their monthly investment by inflation each year. Most importantly, they should remain invested for as long as possible.
Sit tight to prosper through market collapses
One of the interesting observations from Van der Walt’s compounding example is that investors who bought unit trusts and left them untouched earned significant annual returns between 2001 and 2021 despite three big market collapses. The power of compounding and time meant that the 2001 Dotcom Crash, 2009 Global Financial Crisis and 2020 COVID-19 pandemic hardly made a dent. “Investors who panicked at the time and sold their investments would have locked in those losses, while those who stayed benefitted not only from the recovery, but also the resulting compounding effect,” he concludes. Both Cool and Van der Walt encouraged readers to attack the investing and savings dilemma with assistance from the financial advice community.
Writer’s thoughts:
One of the dangers in having the compounding and ‘time in the markets’ debate is that it leaves many investors and savers feeling regret over their past financial mistakes, whether these are by commission or omission. How do you address these regrets and what advice do you give clients who get off to a late start on their retirement savings journeys? Please comment below, interact with us on Twitter at @fanews_online or email us your thoughts [email protected].
