The party is over…. surviving the hangover

Momentum FundsAtWork recently held an Investment Conference in which this presentation was held

The financial crisis postponed most of our retirement dates by a couple of years. However the outlook is not entirely bleak.

If you are young, the financial crisis may actually work in your favour as you’ll be buying into the equity market at a relative low point. Equity still offers the best long-term growth in order to build a substantial retirement portfolio.

If you were aged 25 and started saving in 1969 you most probably will be retiring in 2009 aged 65, since then South African equities have outperformed bonds and cash by about 40 times. Deciding on your long-term strategic benchmark, in other words, your asset class exposure is the most important investment act. Research has shown that the dispersion of returns between asset classes exceed the typical range of returns within each asset class. Asset allocation is the major determinant of the variance of portfolio/asset manager returns. Stock selection and market timing play a minor role and within equities, sector allocation adds more value than stock selection.

But what if you were nearing retirement within the next two years?

Over the past three years South African equities have underperformed bonds and cash. Most retirement funds offer a cash portfolio just before you turn 65, however, retirement planning doesn’t stop when you turn 65. With average life expectancy increasing, the risk is that one outlives your money and therefore one should keep on average 20% to 50% of your portfolio invested in equities, dependent on additional sources of income and savings.

So how much do you need to save?

The rule of thumb is that you need about 15 times your annual salary at retirement for 80% of salary adjusted for inflation, to maintain the same standard of living post-retirement. If your salary adjusted for inflation at 4.5% per annum, and the average return for equities is 10.5%, bonds 6% and cash 5.5%, you will need to save about 18% of your monthly salary from age 25 if you are invested in a typical local balanced fund. But in South Africa most people saving for retirement from a young age are overly conservative and invest in a cash fund or similar portfolios, should this be the case from age 25 then these investors will have to save about 38% of their salary in order to achieve the 15 times rule.

And if you started saving at age 40?

Then you will have to save about 40% of your salary if you are invested in a local balanced fund and probably everything you earn and some more if you choose to allocate to a cash portfolio.

It is hard to overstate the advantage of getting an early start on your retirement savings. Thanks to the power of compounding, someone who invests the same amount and earns the same investment returns from age 25 to 34 and then doesn’t save another penny, will end up with a larger retirement benefit as to someone that started saving at age 35 to 65, the late starter would also have contributed about two times more than the early starter.

Warren Buffet once said “We don’t get paid for activity, just for being right. As to how long we will wait, we’ll wait indefinitely.” “You should never allow the equity markets to guide you, because the market is really there to serve you” - invest for the long-term, be patient about your investments, don’t try and time the market and ignore short term volatility.

Finally, each additional year you work is one more year when you won’t be using your retirement savings. In other words, a late retirement may well be a richer one not only in monetary value but also that social interaction, and physical activity lead to better health as the happiest retirees are those that are still working.