WHY ARE MOST SOUTH AFRICANS SHORT ON RETIRMENT FUNDING?
Why do South Africans enter retirement financially weaker than they should? Three behaviours explain most of it.
It’s a well-known fact that the majority of South Africans will enter retirement in a much weaker financial position than they were in shortly before retirement. Why is this?
The main reason for this dire position can be explained broadly, but I put it down to three main contributors, namely:
Not saving enough
Start saving too late
Bad investor behaviour
Not saving enough
If we consider the average net household savings across the world, then the following becomes evident if we compare South Africans with other countries’ inhabitants.
Annual savings as a percentage of household income:
Sweden 16%
Hungary 14.3%
Germany 11.2%
Ireland 9.0%
Mexico 8.1%
Australia 6.1%
USA 4.9%
UK 4.7%
Portugal 4.5%
Italy 4.2%
South Africa -1.0%
New Zealand -1.3%
The average household annual savings across 29 countries is 6.3% of household income. If we use the simplest maths and look at the difference between South Africa and the global household savings average, we realise we are 7.6% per year behind the global average.
The above means that South Africans have a negative savings culture. In other words, we spend more than we earn. How is this possible? Debt. We live on debt.
We also have a complex economic situation and culture characterised by low incomes and high unemployment, and this does distort the average. While some can retire comfortably, others will retire below the breadline. The South African retirement system largely bears the blame for the dire retirement situation in South Africa.
Many developed countries have a central retirement system for all. Not having access to retirement funds until retirement ensures a decent income on the day you retire. Traditionally, South Africans could and did access their retirement savings when they changed employment.
The recently introduced two-pot system is a step in the right direction to prevent this very bad practice. Hopefully, we will see an improvement in retirement income in the years to come.
Hopefully, people will also realise that relying solely on company retirement funds is not enough. Everyone must take responsibility to build their own wealth.
Start saving too late
In previous articles, I alluded to the fact that the sooner you start investing, the less you have to save.
If you start investing the day you start working in your early 20s, you only need to invest as little as 6% of your income to ensure a financially independent retirement. That is, if you achieve a decent (not the best, but decent) return over the duration of the investment term and you let the power of compound returns do its magic.
If we adopt the habits of most, live life to the fullest in our younger years, buy the fancy cars, always striving to upgrade our toys and prioritise “living now” rather than “saving for the future”, we realise that by the mid-40s we are way behind on retirement provision, and then we have a problem.
All of a sudden, you need to invest more than 30% of your income to get close to financial independence at retirement. If you have not accumulated wealth equal to at least six times your annual income (excluding your primary residence) by your mid-40s, you’d better start thinking about lowering your expectations in retirement.
Many people adopt the attitude of living luxuriously now rather than waiting until retirement, when health issues may impede their enjoyment of holidays, skiing trips etc. That is fine. It is your choice.
The best approach is probably one of balance. A bit of sacrifice in your younger years will just make retirement that bit more comfortable. After all, retirement may last for more than 20 years, and you do not want to be miserable or rely on other people’s charity for 20 years.
Proper planning and implementation of a sustainable, achievable plan can ensure that all your requirements are met. I say this within reason, because some people’s expectations and dreams are beyond the bounds of reasonableness. Make the effort to understand the value of money and how much you actually need to fund a certain income.
When presenting to a group, I like to ask how much they believe is needed to fund a sustainable income of R10 000 per month, assuming the goal is to preserve capital for future inheritance and keep ahead of 5% inflation. The answers I receive vary widely.
I know there are many variables, with returns the biggest, but as a rough estimate, one needs around R2.4 million for every R10 000 you draw on a regular basis. This assumes a return of 10% and an annual income increase of 5%. For a R50 000 monthly income, one therefore requires roughly R12 million if you want to preserve capital.
If you are happy for your capital to reduce over time and be depleted after 25 years, then one should be okay with around R9 million for an income of R 50 000 monthly. Either way, this is a healthy chunk of cash that you need to accumulate, and leave this too late, and the challenge becomes like a mountain to climb.
One of my biggest concerns is the widespread assumption that one needs to invest much more conservatively in retirement. My figures above assume a 10% return, which is not unreasonable; however, they will require some exposure to growth assets, which means you will need to be willing to accept some volatility.
If long-term returns drop to 9% per year and you adopt a strategy of R50 000 monthly income from a R9 million investment, the capital will run out five years earlier than if a 10% return is achieved.
A small return differential of 1% will have devastating results. The “feel-good” of a more conservative portfolio will move the heartache down the line when capital is depleted too early.
Bad investor behaviour
Here, I also want to highlight four problem areas:
Investing too conservatively
Erratic switching of portfolios – trying to time the market
Competing with the Joneses and falling for “hot tips”.
Giving away too much too soon.
Investing too conservatively
Too often, investors adopt an overly conservative investment strategy. Risk profiling is crucial for understanding when an investor will start behaving erratically during a market correction.
It also doesn’t make sense for a conservative investor to invest in a way that heightened volatility will cause angst. Achieving appropriate returns is more important than achieving maximum returns.
When a predetermined capital amount is needed sometime in the future, there are only two factors that will determine the success of the investment. The contribution and the return. The lower the return, the more one needs to contribute to achieve the goal.
Let’s look at an investment goal to accumulate R12 million in 25 years’ time. If a 10% return is achievable, then a monthly investment of R9 044 will be required
If a 12% return is achievable, then a monthly investment of R6 387 will be required If a 7% return (typical long-term money market return) is achievable, then R14 813 will be required monthly.
From the above, it is evident that the price of “feeling good” with a “safe” investment strategy is that one has to invest more than double the monthly amount if a very conservative strategy is adopted. The 12% return mentioned is not unrealistic and is in line with long-term balanced fund returns.
However you choose to invest, it is neither right nor wrong. What matters is understanding the long-term consequences of your decision. It is also important to understand the difference between risk and volatility.
Erratic switching of portfolios
Research based on information provided by leading South African asset managers shows that investors who invest directly with them in their balanced funds achieve, on average, 2% less per year than the funds themselves. This result is attributed to investors switching in and out of the portfolios during uncertain times.
Two percent per year over 20 years results in more than a 40% (simple math again) difference in accumulated capital. That is R12 million versus R7.2 million in our previous example. That in turn amounts to R50 000 per month versus R30 000 per month.
Trying to time the market is a loser’s game. The difficulty is not deciding when to get out of the market. The difficult part is determining when the right time is to get back into the market.
Competing with the Joneses
We often encounter “my friend achieved…” Firstly, friends like to share how much they have ‘won’ but never want to share what they ‘lost’. This is the typical lottery syndrome.
People like to boast about their winnings, but they never divulge how much they have ‘played’ (lost?) in the past. The same applies to investing. Bad investment decisions of the past are buried.
Determine your own strategy and stick to it. Trust your fund managers.
Giving away too much too soon
This is where we, as parents and family members, falter most. Retirees and soon-to-be retirees often short-change themselves by helping adult children and other family members in hard times.
If you have the financial means and surplus funds, help your loved ones by all means. If your funds are limited, be very careful about offering financial help. Children, even adult children, have the ability and time to recover financially.
As a retiree, I cannot recover financial losses. In this scenario, the saying “you must be cruel to be kind” is appropriate. Even if it refers to being kind to yourself.
By saying no, you may just save yourself financially and retain your financial independence. It may also mean that you retain your ability to leave some cash as an inheritance sometime in the future.
Stay safe and invest well.
