Planning for retirement

Retirement seems to most of us to be a specter in the far distant future and procrastination is typically our preferred response to the threat. Provision for retirement however must not be left too late; you literally cannot start early enough.

In the past people started at a corporation at the age of 20-25 and worked there until the age of 65. In their 10 to 15 years of retirement they were completely cared for by their pension fund until their death. Recently, choice, freedom and flexibility have dominated the scene; this combined with a change in working habits has drastically altered the landscape.

People still start work at around 25, but often they change employer two or three times before the age of 35. When changing, they often pay out their current pension fund and use it to buy a car, settle debts or go on holiday. By doing so they damage their retirement propositions more than they could possibly imagine. It seems people just don’t understand the effects of compound interest. Albert Einstein, Ben Franklin and John Maynard Keynes have all been credited with describing compound interest as the eighth wonder of the world.

It is almost cruel that some of the most important years for retirement planning are when you are generally only starting up, want to live your life and your retirement is a distant danger. An example would be the following:

Imagine a person (A) that saves R40 000, in real terms, per year for the first 12 years of their career and then stops. Another person (B) then starts to invest R40 000 per year in real terms for the next 28 years. Together this is the length of the average working life (40 years). If the real return on the investment is 5% per annum throughout, then, at the end of the 40 years person A, who only saved for 12 years, still has more invested for retirement than person B.

Another problem concerns people who do not have a company pension fund and use an RA. Often in times of hardship they stop their contributions to the RA. While this may not seem serious at the time the psychological effects could be extreme. Once the contribution is stopped, you often get used to the extra cash flow and it becomes very difficult to start paying again. A planned break for only a couple of months could turn into a several year struggle to resume payments.

Don’t try to time the market. You cannot do it and will destroy value while trying. Set up an investment plan with asset allocations and stick to it. Contact a financial advisor to help you and make sure you don’t invest too conservatively. Most SA investors fall into the trap of investing too conservatively rather than the converse. Most people are by their very nature risk averse and need encouragement to invest more aggressively.

Part of your investment plan should include rules for rebalancing. Whether this is simple, i.e. rebalancing annually, or more complicated such as rebalancing when the asset allocations go more than 5% off their initial positions, make sure you stick to it. Doing this should decrease your risk in the long term.

One of the great benefits of using an RA or something similar for retirement planning is the effect of rand-cost averaging. It is the easiest way the average investor can practice some form of market timing. It happens when buying into a volatile asset class at frequent intervals and it has a very interesting consequence.

Because a person is investing, say R2 000, per month into equities they buy more equities when the market is low than when the market is high. When the market is high a person buys share X priced at R100 and gets 20 shares. If the market is low the person buys share X priced at R50 and gets 40 shares. This means that they have 60 shares which cost R4 000, or R66.67 per share. This is lower than the average price of R75. By doing this monthly over a long period of time an investor generally buys shares at prices lower than their average over the period.

Lastly, it is important to remember the long-term goal. At 30 or 40, thinking of being 80 might be difficult, but that long-term focus is what is needed. Planning for your retirement can only benefit by adopting this long term ideology. Try to ignore short term volatility and take Warren Buffet to heart when he says, “Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participating in it.”