Retiring with dignity

The risk of capital loss is a concept that is, without a doubt, well-known and feared by virtually every investor. It continues to dominate investment decisions and investors seem to be blissfully unaware of other, equally important, risks involved in making decisions surrounding their retirement. Another equally important risk is the danger of not saving enough for retirement. The outcome is that, today, the majority of retirees unfortunately need to deal with this harsh reality on a daily basis, when their monthly income just doesn’t meet their lifestyle requirements.

So why does the notion of losing capital play such a prominent role in the decision-making process of investors, often to the detriment of not meeting their income needs at retirement?

The concept of behavioural finance is useful in trying to explain why this occurrence tends to happen. The powerful force of human emotions often causes investors to go against good investment practice. In times of market uncertainty, investors often act irrationally and lose sight of their long-term financial goals. They allow the most recent historic events to dictate their behaviour, leading to a short-term investment focus that is sure to destroy value. Consequently, investors tend to experience the risk of capital loss as an immediate threat to their savings and a scenario that could realistically occur today. In trying to minimise this threat, they often end up being too conservative when making investment decisions. On the contrary, the realisation of retiring with inadequate savings will only be evident at retirement. It is not seen as an immediate threat and takes the focus off meeting their retirement needs. It is obvious that human emotions can have a detrimental impact on investors’ retirement goals and should therefore not be underestimated. Financial intermediaries have a critical role to play in protecting the client against their own investment imperfections and retaining the client’s focus on their long-term retirement goals.

Let’s consider some of the imperfections investors need to be protected against and the detrimental impacts thereof:

The first mistake investors tend to make is to postpone saving for retirement. It is often argued that they are too young to be thinking about retirement. The need for a car or other consumables is high on the priority list of purchases when their first few paychecks or bonuses arrive. Unknowingly, they cut down on their investment time horizon and drastically reduce the probability of meeting their retirement goals. The effect of compound interest over time is often referred to as the eighth wonder of the world and is one of the best investment tools that should not be overlooked. Investors should be encouraged to start saving as early as possible, because the longer their investment time horizon, the better the effect of compound interest and the probability of meeting their income needs at retirement.

Secondly, when investors finally start investing for retirement, they tend to underestimate the portion of their salary that needs to be saved. Investors who start saving in their early 20s need to save between 13% and 20% of their salary if they want to retire at 55, as opposed to 44% and 70% if they only start saving at 40 or 45. The longer investors wait to save for retirement, the higher the portion of their salary they will have to contribute to give them any chance of retiring with dignity at 55.

Thirdly, investors tend to be too conservative and invest for retirement without holding sufficient or any inflation-beating (real) assets. Statistics from ASISA confirm the conservative nature of the South African investor. The retail market composition indicates that 32% of retail investors are currently invested in money market funds. History shows us that this portion remains high and tends to fluctuate around 30%. These investors seems to be comforted by the fact that the probability of losing their capital is virtually zero, but are seemingly unaware that their investments rarely beat inflation. The picture looks even worse on an after-tax basis. Another market, dominated by extremely conservative investors, is in our neighbouring country Namibia. Surprisingly, nearly 85% of Namibian investors are invested in money market type funds with this phenomenon being evident for quite some time. Even though the tax structure on interest is more favourable in Namibia, there is still an enormous task that awaits the Namibian financial intermediary, in terms of educating investors on the devastating effects of retirement savings not beating inflation.

Why is it so important to beat inflation? The main reason is that inflation causes money to lose its purchasing power. In simple terms, try to remember what a bread or newspaper cost a few years ago versus what it costs today? Or maybe how much house or car prices increased over the years? Given this, it is essential that retirement savings beat inflation over time. If investors are not able to achieve this, they will have to downsize their lifestyles to enable them to live off their retirement savings. This harsh reality surprises many retirees today and shatters their dream of retiring with dignity after a lifetime of hard work.

Table 1: Annualised from 31 MAR 1967 to 31 JAN 2010

Returns (R)

Real Returns (R)

Std Deviation

Real Std Deviation
















Source: Glacier Research (Note: JSE Returns excl Dividends)

Consequently, it is vital to hold real assets in your portfolio. Equities are by far the best performing asset class over the long term and the best inflation-beating asset (positive real returns) to hold. However, short-term performance can be extremely volatile at times (see table 1). Despite this, studies have shown that equity returns become rather predictable over time, as is evident from the graph below where the average annualised return over the last 20 – 30 years was close to 20%. In essence, if an investor has a reasonable time horizon ahead of him he can actually not afford to exclude equities from his portfolio.

graph1-6852Source: Glacier Research

It is clear that investors need to hold real assets to give them any chance of meeting their retirement needs. However, increasing the exposure towards real assets in a portfolio will increase the risk of such a portfolio. Conservative investors should definitely not be discouraged and think that their default option is cash only. They should understand that it’s imperative to maintain a good balance between their psychological risk profile and their needs for retirement when making investment decisions. The limited risk they are willing to take on, in line with their psychological risk profile, makes it a challenge to beat inflation in the long run. There are however excellent fund managers in the flexible categories that have proven their ability to protect capital in market downturns while still managing to deliver inflation beating returns in the long run. Managers with the ability to successfully move between asset classes, in different and difficult market conditions, are however scarce and careful consideration should be given when picking these funds.

Finally, as investors reach retirement, it is essential that the investment process does not end here. The biggest mistake investors tend to make is to move all their saving into cash the moment they retire to entirely reduce investment risk. Many investors are unaware of the detrimental effects of moving too conservative too quickly. It can mean the difference between retiring comfortably versus the harsh reality of depleting ones capital. Owing to improvements in medical technology, people tend to live longer and retirees need an income that will last another 20-30 years, on average, after retirement. This is a very long time in investment terms. It is therefore crucial to grow one’s asset base above inflation for a few more years after retirement at levels of risk that are more appropriate for a client drawing an income. The graph below indicates that a client’s capital can last an additional 8 years by investing in funds that deliver returns 4% above inflation while drawing a reasonable income.


Source: Glacier

Financial intermediaries have a pivotal role to play in guiding investors to successfully plan for and retire with dignity. The intermediary is that person who is willing to walk alongside his client every step of the way, someone whom the client can trust and who is the first one to protect the client against himself when the road gets rocky or uncertain. While proper communication is critical to clarify retirement goals and impart knowledge, more important considerations are all the relevant risks (referred to in this article) which should be taken into account.

Everyone wants to retire with dignity, especially after having worked a lifetime for one’s hard earned cash. However, the reality is that very few people are able to get it right and unfortunately, there is no second chance.

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