Wealth creation and preservation: Brought to you by Sanlam
Shakespeare said: “I wasted time, and now time doth waste me.” I doubt he was referring to retirement planning, but the comment is still appropriate.
Retirement seems to most of us to be a spectre in the distant future and procrastination is typically our preferred response. Provision for retirement, however, must not be left too late. You literally cannot start early enough, writes Albert Botha, investment analyst, Glacier by Sanlam
Why we don’t save
The benevolent employer has gone
In the past people started at a corporation between the ages of 20 to 25 and worked there until the age of 65. In their 10 to 15 years of retirement they were completely cared for by their pension fund until their death. Recently choice, freedom and flexibility have dominated the scene. Combined with a change in working habits this has drastically altered the landscape.
Living the high life
People still start work at about 25, but often they change employers two or three times before the age of 35. When changing, they are often paid out their current pension fund and use it to buy a car, settle debts or go on holiday. By doing so they damage their retirement propositions more than they could possibly imagine. It is almost cruel that some of the most important years for retirement planning are generally when you are starting up, want to live your life and your retirement is a distant danger. But by ignoring retirement savings at an early age we miss out on what Albert Einstein, Ben Franklin and John Maynard Keynes called the “eighth wonder of the world” — compounding interest. Compounding interest is the power of your money to make more money for you.
For example, Mike starts off saving R40 000 a year and in every subsequent year he saves 5% more. He does this for 12 years and then stops investing, but allows his current investments to continue to grow. A year after Mike pays his final annual instalments of R68 413, his twin brother Craig starts to save by paying R71 834 a year, which also increases by 5% every year. Craig continues to pay an instalment for the next 28 years, ending with annual instalments of R268 190.
At the end of this 40-year period, Mike invested a total of R636 685 over 12 years, whereas Craig invested R4 195,305 over 28 years. Yet at the end of the period, Mike has R18-million to retire on compared to Craig who has R16-million, despite saving R3,5-million more.
Erratic contributions
Often in times of hardship people who do not have a company pension fund and use an RA stop their contributions to the RA. Although this may not seem serious at the time the effects could be extreme. Once the contribution is stopped, you often get used to the extra cash flow and it becomes difficult to start paying again. A break for a few months could turn into years of struggling to resume payments.
How to start saving
Don’t try to time the market
You cannot do it and you will destroy value while trying. Set up an investment plan with asset allocations and stick to it. Contact a financial advisor to help you and make sure you don’t invest too conservatively. Most South African investors fall into the trap of investing too conservatively rather than the converse. Most people are by their very nature risk averse and need encouragement to invest more aggressively. Part of your investment plan should include rules for rebalancing. Whether this is simple, i.e. rebalancing annually, or more complicated, such as rebalancing when the asset allocations go more than 5% off their initial positions, make sure you stick to it. Doing this should decrease your risk in the long term.
Rand cost averaging
By investing by debit order every month, you actually benefit from weaker markets. When a person invests, say R2 000, per month into equities they buy more equities when the market is low than when the market is high.
When the market is high a person buys ABC share priced at R100 and gets 20 shares. When the market is low the person buys ABC share priced at R50 and gets 40 shares. This means that they have 60 shares that cost R4 000, or R66,67 per share. This is lower than the average price of R75. By doing this monthly over a long period of time an investor generally buys shares at prices lower than their average over the period.
Focus on the long term
Lastly, it is important to remember the long-term goal. At 30 or 40, thinking of being 80 might be difficult, but that long-term focus is what is needed. Planning for your retirement can only be of benefit if this long-term ideology is adopted. Try to ignore short-term volatility and take Warren Buffet to heart when he says: “Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participating in it.”
Benefits of using an RA
If you have a marginal tax rate of 30% and you feel you could invest R1 000 more a month after tax, you could choose a savings plan and invest that R1 000.
On the other hand if you still have space in your pension contribution or RA you could invest R1 428,57 a month pre-tax for the same net effect after tax. In other word, your take-home salary would remain the same.
You are in fact investing 43% more pre-tax than you would after tax. This becomes more pronounced the higher your marginal tax rate becomes.
Another benefit of using an RA is that it has many of the same tax benefits as a pension fund.
Where a normal investment is taxed on capital gains and interest payments, the investment returns of the assets underlying an RA is tax free.
When the RA is transferred to either a guaranteed annuity or an investment-linked life annuity at retirement, only the income drawn is taxed whereas the investment returns are not.
Although the tax benefits are substantial they are not the only benefits of contributing to an RA. For many employees, the pension options offered by their employers are very restrictive, lacking variety and flexibility.
The wide range of investment options available in an RA increases the number of choices an investor has. This flexibility allows an investor to choose safer alternatives, which include more cash, or more aggressive options with more equity and offshore assets.