These financial times are out of joint. The wealth explosion in recent years has been at odds with the economic reality on the ground. While financial markets partied on, drunk on too much liquidity and negative real interest rates, the real world grappled with the fall-out from Covid containment measures: millions of people losing their livelihood, entire economic sectors obliterated, supply and labour constraints and record debt levels.
What cursed spite for those born at the wrong time, who have to set the retirement affairs right during the hangover period that will surely follow.
They would have seen their investment accounts balloon during this phase, fueling a sense of complacency about their retirement prospects. But the dramatic inflation surge and the resultant urgency to ratchet up interest rates, is killing the mood. And it may get worse as recent geopolitical events, especially as they affect energy prices, point to growing inflationary pressures.
The retirement transition is precarious at the best of times. You have to make some hard decisions, and probably live with the consequences for the rest of your life. You risk locking yourself into a strategy or a product that may not suit in a few years’ time. Should you choose a guaranteed annuity you are stuck with the one you choose. A living annuity comes with more flexibility, but also the risk that your investment and draw-down strategy will not serve you later.
Then there is timing risk, because what happens in the markets ahead of this period could still scupper your plans. Retirement is when your savings are near their peak, which means the impact of any volatility is most pronounced, in absolute terms.
To mitigate this risk, invest with your time horizon in mind. Timing risk is a bigger threat for those buying a guaranteed annuity, as their investment term is short. You need to start de-risking and preserving your savings a few years ahead. That means gradually lowering your exposure to equities and investing more in bonds and cash. Cash should hold its nominal value while you are hedged against falling bond prices as these translate into lower annuity prices.
Alternatively, those choosing a living annuity might want to invest conservatively, for more stable returns. But this won’t provide the above-inflation growth needed to make savings last over an extended retirement.
In South Africa, investing in a well-diversified high-equity portfolio has historically delivered superior returns over periods of five years and longer, so this strategy should make your savings last longer and/or afford you a higher draw-down.
A sustained spike in inflation and the necessary policy response – higher interest rates – is generally not good news for your share portfolio.
It’s a double whammy for retirees. Higher inflation ratchets up living costs, while steadily rising interest rates may result in some years of negative investment returns, as happened during the mid-Seventies.
In such an environment, you may lose your nerve, and switch either to a guaranteed annuity, or to a defensive portfolio. This would mean locking in your losses and a lower income for life. But even if you do not change your strategy, you may lock in some losses as drawing income makes you a forced seller in a bear market.
Each year, you get only one chance to change your income. If the market drops just after that, you are drawing down at a higher rate. If your portfolio drops 20%, your 5% draw-down rate becomes 6,25%. If your portfolio does not recover, and inflation ratchets to 10%, you are already at 7,5% the following year. If this persists it will considerably shorten the lifespan of your savings.
For high-cost investors, switching to a low-cost living annuity (charging 1% or less per annum), would more than neutralise a 20% loss in their portfolio value over the long term. But, even then, you should cut back since a slight lifestyle reduction can have a meaningful impact. If you could, say, spend R2,000 less per month you will be saving R24k per year. And if you are drawing down at 5%, that effectively replaces capital of R480k.
The past few years may have inflated investors’ sense of their wealth and market returns, both of which may prove unsustainable. People in or approaching retirement should perhaps revisit their lifestyle expectations and moderate their spending plans, on the assumption that their portfolio, even if it is well-diversified, may give back some of the gains of the last three years.
Yes, recent developments are already priced in, but each could take a turn for the worse. Rather get a pleasant surprise if it doesn’t happen than a nasty shock if it does.
Andre Tuck is a Senior Investment Consultant at 10X Investments
The content herein is provided as general information. It is not intended as nor does it constitute financial, tax, legal, investment, or other advice. 10X Investments is an authorised FSP (number 28250). 10X Index Fund Managers (RF) (Pty) Ltd is a Manager registered under the Collective Investment Schemes Control Act, 2002
