Consider these factors when planning for retirement
By Samuel Rossouw
23 June 2020
Depending on where in the life cycle of an investor you find yourself, you will experience different emotions during market crashes such as the one we have recently experienced.
However, how you respond and your actions following these kinds of market declines, have a significant influence on the success of your financial planning and where you will find yourself ten or even 20 years from now.
What often feels like the most obvious response after a market crash – such as a shift to a money market account, switching to unit trusts that have performed better or a flight to gold – often do more damage to your long-term planning than it does to help your situation.
Market corrections often happen very quickly and unexpectedly, and the ship will leave the harbour too soon for investors who wait on the quay until the storms subside.
There are many options that long-term investors can utilise during times of market declines to ensure that their long-term plan is still in order. Pensionaries with R10 million’s worth of retirement capital, a potential investment term of 30 years, inflation-linked increases (assume 5%) and who experienced a 5% drop in capital (thus reducing their capital with R500 000) can completely erase this drop by reducing their annual income escalation by half a percentage point, thus taking only an annual increase of 4.5% instead of 5%. The table below shows the different combinations that could lead to the same result.
Obviously, some adjustments are easier said than done. If things are already a bit tight (unlike in the example above), it is very difficult to reduce your monthly income.
Your options would then be to take slightly lower increases in future or a combination of lower increases and investments that get a slightly higher yield.
The latter must, however, be treated with caution, because it is this quest for a higher yield that can lead investors down the wrong path.
There is a saying that you cannot make good wine from sour grapes. Similarly, you cannot make defective planning disappear by investing in more aggressive investments. Temporary market declines also do not represent a permanent loss of capital and therefore investors will not need to have the above adjustments in place for the full term of their planning. When circumstances allow, they would be able to make positive adjustments again.
The graph below shows the probability of failure for a combination of different withdrawal rates and projected rates of return should a retired person’s funds have to last for 30 years after retirement.
Although, statistically, aggressive portfolios should be able to maintain high withdrawal rates, things rarely go smoothly, and it can still fail as a strategy. The lower your projected rate of return and the higher your withdrawal rate, the greater the chance of failure. The green blocks (where you need to be) simply show the combinations of safe extraction rates while the red blocks indicate danger zones.
The table also shows that failure is basically guaranteed if you use conservative funds only (e.g. cash) and a withdrawal rate of more than 4.5%. Growth assets are therefore very important for preserving your capital over the long term.
Another reason why more aggressive portfolios can fail is because investment returns cannot be illustrated by way of a straight line. Thoughtful investors should adapt their planning to circumstances and the volatility of markets.
It can therefore be meaningful to split your monthly withdrawal into three components:
We know that an average return of 10% over 20 years does not mean that your investments will grow with 10% every year end therefore you will, during the period of investment, have to face fear and a false sense of security from time to time. Constant monitoring of your financial situation is of critical importance.
Planning for retirement
Which factors do you need to consider when doing your retirement planning? It is very important that you know how much exposure you need to growth assets (such as equity and property) to be able to continue with your withdrawal rate over the long term.
Also be aware of the characteristics of unit trust investments. Take note of the asset allocation and consider what the worst-case scenario for the given allocation would look like. You will have to be able to comfortably sit through the worst-case scenario without wanting to adjust or make shifts.
Uncomfortable times of volatility and weak performance does not necessarily mean that your retirement plan has derailed. There are many “small” adjustments that can be made to ensure that your retirement plan is still successful. The annual review of an annual increase, lower average increase or even lowering your annual income will have a significant impact on your fund values.
Do not change your asset allocation to be more aggressive purely based on the fact that you are trying to work against market declines or weak planning; this strategy has a low probability of success. There is a significant probability of failing when you fail to plan. Therefore, make the necessary effort to put a proper retirement plan in place, one that is adjustable and practical.
Samuel Rossouw is a certified financial planner and director of ProVérte Wealth and Risk Management. Contact him at email@example.com.
Although all possible care was taken in the drafting of this document, the factual correctness of the information contained herein cannot be guaranteed. This document does not constitute advice and anyone planning on taking any financial action based on this document, is strongly advised to first consult with their personal financial advisor. ProVérte Wealth & Risk Management is an authorised financial service provider with FSP no. 5966.