The main reasons for saving include creating a buffer against unforeseen expenses and covering future liabilities such as your children’s education and retirement.
One of the main obstacles to saving is the propensity of South African consumers to spend. A proliferation of credit options in recent years and mortgages and hire-purchase agreements resulted in the household debt-to-income ratio surging close to 80% of income.
During National Savings Month, financial industry stakeholders are calling upon South Africans to resist the urge to spend and focus instead on saving. Wilhelm Janse van Vuuren, a wealth manager at FNB Private Clients, says you should make a distinction between savings and investments.
“Savings,” he says, “can be seen as short-term measures to cover the events already mentioned, while investments fall into your long-term plan for retirement.” He says an early start to saving is essential in both instances.
The July 2010 Old Mutual Savings Monitor, which surveys the savings habits of 1 000 metro families in the LSM6 (living standards measure) to LSM10 categories, reveals that those who undertake long-range financial planning end up saving more.
The best way to prepare for retirement is to gain a full understanding of your future financial needs at an early stage. Most financial planners suggest you begin planning for your retirement five to 10 years before your intended retirement date.
A comprehensive financial review will enable you to assess the contribution each of your savings initiatives will make to your eventual retirement capital.
There are three golden rules to making adequate capital provisions. The first is to save 15% of your gross salary consistently over your working life. The second is to preserve your pension benefits each time you change employment. And the third is to secure the services of a competent financial adviser before retirement.
You should also avoid the common mistake of neglecting aspects of fi nancial planning during your retirement. How much should an individual squirrel away for retirement? There’s no easy answer to this question because of the complex variables at play before and during retirement.
The inputs to the retirement savings equation include the time to retirement, forecast investment returns, likely levels of inflation and life expectancy, among others. “The answer varies depending on these base assumptions,” says Rian le Roux, an economist at Old Mutual Investment Group SA.
“The only conclusion one can draw is most South Africans save way too little.” But economists are always ready for a challenge. To illustrate the uncertainties in the retirement saving process Le Roux described a “bare bones” retirement scenario.
Assuming no inflation, zero wage increases and zero investment return, an individual who worked for 35 years, retired at age 60 and wanted to draw 75% of his pre-retirement salary for another 25 years would have to save R54 of each R100 earned. Of course, you can only apply such an example to a modern-day Robinson Crusoe.
In the real world you have to allow for inflation at around 6% a year, annual wage increases of 9% (assuming career progress) and a conservative 3% a year real investment return. Under this scenario — assuming the saver decides to draw only 6.5% of available retirement capital as income in the first year — an individual saving 13% of income for 35 years would retire with only 32% of his final pre-retirement income. A real return of just 3% might not be enough.
Rob Formby, director of retail operations at Allan Gray, says the role of real investment return in retirement savings cannot be emphasised enough. Investment performance in excess of inflation contributes to effective long-term savings.
Assuming you save 12% of your income over 35 years to ensure a comfortable retirement, each 1% improvement in overall investment performance increases your postretirement income by 31%. The huge improvement demonstrates the magic of compound interest — the interest (return) earned on interest in your retirement funds.
A successful retirement saver requires discipline. Apart from preserving funds when changing jobs, you need to behave like an investor. Research confirms the performance of an average investor in a fund tends to lag the performance of the fund by some margin. This is largely caused by emotional and inappropriate short-term decisions, such as switching from one investment option to another to chase past performance, caused by panic or being overly conservative.
“Try not to undermine a long-term saving approach with short-term, emotional investment decisions,” says Formby. Another mistake savers make is to follow an investment direction even if it’s not particularly logical. “This is well illustrated by a study that shows fund flows as a percentage of assets against fund performance,” says Formby.
Investors tend to sell when the market is low and buy when it is high or rising. In other words, the appetite to buy increases as the price of the product goes up. Saving is driven by the “herd” mentality. The very low levels of household saving (actually negative when expressed as a percentage of GDP) exhibited in South Africa are a reflection of the preference for consumption
expenditure over saving. “
For a portion of our population there is no option of saving; for the rest, saving is an option, yet they still often elect to follow the crowd and spend, even though the consequences at retirement are devastating,” he says.
The Old Mutual Savings Monitor confirms this view Individuals with higher incomes are saving less this year than last. There is also an inverse relationship between the economy and savings activity.
Leon Campher, chief executive of the Association of Savings and Investments SA, says: “When consumers believe their income prospects are improving as a result of favourable economic conditions, better jobs and rising house prices, they tend to save less.”
Elias Masilela, a board member at the South African Savings Institute (Sasi), says that, on a per-income basis, low-income earners are better savers than their wealthier counterparts. “There is one fundamental reason why this is the case and that is lowincome earners don’t have access to credit,” he says.
South Africa’s poor live within their means and their financial planning process centres on the income they actually generated in a particular month. Three years ago Sasi conducted research into savings patterns among low-income families.
The study showed the preferred method of saving was by investing in housing, followed by investing in their children, basic bank accounts and pooled investments, such as stokvels, NGOs, women’s groups and similar organisations.
“By delaying ‘saving for tomorrow’ in favour of ‘spending for today’ a saver is gambling that they will be able to make up any shortcomings at a later date,” says Formby. These individuals fall further behind the retirement curve with each passing year.
“Many discover far too late they are underprovided and will have to work way past normal retirement age,” says Le Roux. Late starters also face an increased risk of being lured in by a “get rich quick” scheme. Saving for retirement is about starting early, saving conscientiously and maintaining discipline.