James Fraser, chief operating officer at PPS Investments
Markets have historically rebounded from crises, but this provides little comfort to investors as they witness a sharp decline in assets they have accumulated over the years.
The effect of the stock market decline on future retirement income will depend
largely on whether the stock market recovers some or all its losses, and the age of
impacted investors.
In 1994, US financial planner William Bengen introduced the 4% withdrawal rule using historical simulations. He found that a first-year withdrawal rate of 4%, followed by inflation-adjusted withdrawals in subsequent years, should allow capital to last at least 30 years. In rand terms, you would need an invested amount equal to annual expenses multiplied by 25.
A study by Wade Pfau in 2010 contradicted Bengen’s finding, establishing that a 4% real withdrawal rate is surprisingly risky given that it only provides a safe retirement in four out of 17 developed market countries over 30 years. In addition, at least 50% of growth assets (like equities) were required to maintain the withdrawal rate.
This is particularly concerning given that the average annual percentage withdrawal in SA is about 6.5% according to a Just SA study. Another issue is that people are living longer. Planning for a 30-year retirement used to be sufficient, but data from PPS members suggest that the average professional male will live to 95 and the average professional female to 100. Depending on their retirement age, people will likely have to start planning for their retirement to last around 40 years.
In their 2019 Global Investors Study (GIS), Schroders looked at investor behaviour
during market volatility. During the fourth quarter of 2018, the MSCI World index of global equities fell sharply amid concerns for the global economy. In direct response to this period of market volatility, most investors surveyed made changes to their risk profile (70%). Of these, 37% moved some of their portfolios into lower risk investments, and 35% moved some of their portfolios into higher risk investments. One in five people (21%) moved some of their portfolios into cash.
In recent years, a similar trend has been observed amongst South African investors.
ASISA industry data has shown a substantial increase in net flows into fixed interest
categories, while South African equity has seen outflows since 2016.
Historical returns from asset classes, both locally and abroad, he adds, have shown
that equity consistently outperforms cash and bonds over the long-term. “While local bonds currently provide attractive yields, interest rate cuts have substantially curtailed returns from cash. Moving into a lower risk profile can reduce investors’ exposure to volatility, however, it could reduce your ability to reach desired retirement goals.
The economic turmoil caused by Covid-19 has resulted in some investors dipping into their savings, while others paused their monthly retirement savings to cut expenses While temporarily halting pension contributions may seem immaterial in the long run, says Fraser, the opportunity cost of missing out on the tax relief and the lessened effect of compounding exacerbate the negative impact. Investors who are unable to increase subsequent contributions to make up for periods of reduced savings can find themselves struggling during retirement.
In the professional market that we service, 7% of investors paused their contributions since March 2020, while 15% reduced their annual debit order escalation. It is also encouraging to see that only 1% reduced their risk profile indicating that they have chosen to maintain their savings goals despite the headwinds this year,” says Fraser. “While market declines are unpredictable and difficult to forecast, it’s a natural, an inevitable part of investing.
A diversified portfolio, he adds, provides investors with an opportunity to create a
smoother return profile over the long run, as it is better able to withstand fluctuating market conditions. A blend of asset managers is best suited to take advantage of opportunities, both locally and abroad, at different times in the cycle, offering optimal diversification to augment portfolio.
Staying invested, rather than responding to market events, helps to ensure that you
achieve your financial goals in the long term.