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Three things you must understand for a successful retirement

14 August 2012 Gareth Stokes
Gareth Stokes, FAnews Online Editor

Gareth Stokes, FAnews Online Editor

One of the best ways to understand a complex topic is to break it down to first principles. By applying this theory to retirement you can cut through the complex jargon favoured by the life industry giants and build a secure nest egg on just three concept

I have attended numerous presentations on retirement over the past seven years. These include the entry level “how to save for retirement”, intermediate level “how much is enough” and more complicated “life stages and asset allocation in retirement” topics. Needless to say I have witnessed my fair share of doomsday presentations too. Each retirement index or monitor concludes that only six in 100 (the industry’s favourite ‘guesstimate’) of savers will reach retirement with enough capital to see them through their golden years. I had all but given up on the topic when Johan Gouws, Executive Director at Absa Investments, delivered his comprehensive Life Stage Investing presentation at the group’s half-year media briefing, held in Johannesburg on 25 July 2012.

Time, return and risk...

You cannot think about saving for retirement without considering time. Gouws simplifies this concept by dividing an individual’s lifespan into two parts: the working years leading up to retirement (typically spanning 30 to 40 years) and the years after retirement (say 25 to 30 years). The overarching financial plan requires that you save and invest to create sufficient wealth for financial independence at retirement during the first stage, and then preserve your capital during the second. Your retirement – although not a line drawn in sand – represents the shift from wealth accumulation to wealth consumption and wealth preservation.

Time is important because of compound interest – the ability to earn interest on interest for the duration of your investment. You accumulate more wealth by starting with you savings plan earlier and contributing to it for longer periods. As an example: Consider R1 invested in a bank account earning 10% per annum… After 10 years you will have R2.59, after 15-years R4.18 and after 25-years R10.83. An urban legend attributes the science legend Albert Einstein with the line: “Compound interest is the eighth wonder of the world!” But it does not matter who coined this phrase – what matters is making this time-based miracle part of your long-term investment thinking.

This brings us to the second and third cornerstones of retirement savings, namely the concepts of risk and return. Most financial planners address risk and return in the same breath because they are so closely related. From a laypersons view the more risk involved in an investment, the higher the return. So – for example – cash is the least risky investment, followed by bonds, listed property and shares. Unfortunately the risk associated with a particular asset class does not always reflect in its returns over the short-term.

You cannot bank on real returns, regardless of risk

At present the lowest risk investments in cash and near-cash instruments are yielding negative real returns! At the same time listed properties – viewed as lower risk than equities – are generating almost twice the return from the stock market. Fortunately your clients can leave the tough asset allocation decisions to professional asset managers. As for financial advisers, your mission is to balance risk and return at each stage of your client’s life. “Not taking sufficient investment risk in order to achieve the required real returns is a major retirement saving pitfall,” says Gouws.

Inflation is the dark horse in the retirement funding landscape, because it erodes the value of your money over time. Assuming an inflation rate of 6% per annum the R100 note in your wallet today would be worth – in terms of its purchasing power – R75 in five years, R42 in 15 years and just R17 after three decades. It is worth dwelling on Gouws’ warning: “The risk in your client’s portfolio must provide return in excess of inflation (a real return) or the entire savings equation falls apart…” Things fall apart in the absence of discipline too.

Discipline, discipline, discipline

A successful real estate investor often chants the “location, location, location” mantra. For retirement savers and investors “discipline, discipline, discipline” is more appropriate. In each of the presentations mentioned in my opening paragraphs the topic of preservation raises its ugly head. “South Africans have a horrible habit of dipping into their retirement savings when they change jobs,” says Gouws. According to the 2011 Old Mutual Retirement Monitor a staggering 51% of job hoppers withdrew cash benefits at this critical stage. Only 40% transferred their funds to their new employees, while 10% either stayed in their previous pension fund or moved them into a preservation fund.

“The best thing you can do for your clients is to get them to view retirement as a period of transition rather than a once-off event,” concludes Gouws. Once your clients understand critical retirement concepts such as time, return and risk they should be ready for the “how much is enough” and “life stages” discussion. Absa Investments singles out early career, mid career, late career, early retirement and late retirement as six possible life stages… It is imperative that your client’s risk and return dynamic changes as he or she moves through each of these stages.

Editor’s thoughts: Thinking about retirement savings in terms of time, return and risk may be an oversimplification… However – a thorough understanding of these basic concepts – tempered with an appreciation of the erosive effects of inflation and the need for discipline – should empower ordinary citizens to better prepare for retirement. Are the products available for retirement savings too complex? Add your comment below, or send it to gareth@fanews.co.za

Comments

Added by Nick, 15 Aug 2012
Attitude and aging I am convinced that much of what happens to us in life is ruled by attitude. Our ambitions, aspirations, achievements, emotions, potential, happiness, and even health, are all dominated by our attitudes. All that we really have in life is our consciousness, our awareness of ourselves and everything that is around us. We are aware of ourselves and the world around us through our senses of sight, hearing, touch, taste and smell. Our senses encode sensory experiences into electro-chemical signals which are sent as nerve impulses to the brain. The brain processes these nerve impulses and we perceive light, shade, shapes, movement, colours, music, flavours and scents. The brain actively constructs patterns and meanings from the streams of nerve impulses coming in from our senses. But we all construct our own patterns and meanings. The sharp images which the brain constructs are very different from the blurred, jittery upside-down images which stimulate the retina of the eye. Your perception of red and yellow might be completely different from my perception of these colours. Aromas which please you might disgust me. Flavours which delight your taste buds might be abhorrent to me. Music which I enjoy might not please you at all. We are all different and we all have our own individual perceptions and interpretations of the world. We each have our own realities and our own illusions, and that is all that we know. We develop predispositions in the ways that we perceive, interpret and make sense of ourselves and the word around us. Some people really do look at the world through rose coloured spectacles. Some of us are optimists, some are pessimists. Where someone sees a half full glass someone else sees the glass half empty. Where someone sees a problem someone else sees a challenge. Where some people experience fear others experience excitement. Our predisposition to view our world, ourselves and our experiences in a particular way, and to respond in particular ways, is the basis of attitude. Sometimes we are aware of our attitudes: mostly we are unaware of them. When we are aware of our attitudes, we may choose to deny them. We are our attitudes. If we own up to our attitudes we can learn to influence them. We can choose to be positive, to be optimistic, and to see things in a better light. We can look for the best in people. We can count our blessings, look for silver linings and find gold at the end of rainbows. We can choose to be happy. Attitudes are self-sustaining, self-perpetuating and self-fulfilling. If you look out of your window on a rainy morning and decide that the weather is ‘miserable’ it is likely that you will have a miserable day. If, on the other hand, you contemplate the miracle of rainfall and how it sustains life, and how fortunate you are not to live in a region plagued by drought, or floods, or earthquakes, then just maybe you will have a better day. Perhaps you can recall a time when you had a different attitude to rainy days. As a child you might have delighted in splashing in puddles and feeling raindrops on your face. How we used to love the walking in the rain. How’s you attitude to walking in the rain right now? If we choose to believe the negative stereotypes of aging and retirement, if we choose to believe that because of our age it is too late to do anything worthwhile, then we will probably be proved right. If we convince ourselves that we have some fatal illness, our minds might be quite capable of shutting down the body’s immune system. On the other hand if we adopt a young-at-heart, positive attitude to aging and retirement, this can greatly boost our chances of having a satisfying, fulfilling, successful and enjoyable life. The choice is ours.
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Added by Greg, 14 Aug 2012
Not very surprising that ABSA convieniently forget to mention longevity. Longevity can play an even larger role in retirement with interest rates at their current levels. There's a big difference between using your retirement savings for a lifespan of 10 years versus 40 years.
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Added by Hansie, 14 Aug 2012
All the above is true and well known by experienced advisors. However the Minister and the FSB have removed 60% of the commission income that intermediaries receive on RA's. Very few intermediaries still marker RA's to clients due to this. Most of the 60% of commissions have been absorbed by the insurance companies as "disclosed costs". It is now simply not cost effective to market RA's. I personally would not have a problem if my full (pre Jan 09) commission was disclosed to my clients. They value my advice and respect that I should receive a professional fee for service and advice given. I cannot understand how RA's could be treated the same as endowments. And all of this happend right after Minister Manual said that we should create a culture of savings in SA! All studies have proven that RA's are one of the most effective ways to save for retirement. This arbirtary reduction in commissions have killed the goose that lies the golden eggs. The only way forward now is unit trust-linked annueties and it will take most inremediaries years to build a reansonable book- so few will. Other intermediaries have responded on this to you before. Can something be done or does government really want millions of old people dependant on the state? The current situation is compareable to the school book fiasco!
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