Savings and retirement considerations
Saving and investing consistently is essential when planning to build a large enough nest egg to retire comfortably. The latest 10X Retirement Reality Report showed that out of 15 million economically active South Africans, 67% have no retirement plans. Your retirement savings should enable you to support yourself and maintain your lifestyle after your working years. Building this nest egg does not happen overnight.
With advances in technology and medicine extending lifespans, it is expected that the average person may need to prepare for 20 years of retirement if they retire at 65. Keeping up with the rising cost of living (inflation) is key - whether you want to retire early or are planning to supplement a corporate pension.
Retiring comfortably is a result of contributing early, contributing consistently and allowing your funds to compound over time. Below we highlight some of the key considerations to retiring comfortably.
Compounding
In simple terms, compounding is achieved when returns from your initial savings and investments are reinvested and those returns then deliver further returns. Over the long term, compounding will have a massive impact on portfolio growth. Compounding goes hand -in-hand with long-term saving and investing. Allowing returns to compound from a young age is a proven strategy when building up retirement funds. The power of compounding means that time is a powerful tool when looking to beat volatile movements and achieve good returns.
Staying the course in a volatile market
A major concern for most investors and savers, when looking to grow savings for retirement, is market volatility and the market moving against them. Volatility measures the degree to which asset prices move up and down over time. The larger and more frequent these moves, the more volatile the investment is. More volatile investments are regarded as carrying a higher risk.
An important caveat to this is that short-term volatility does not alter the long-term trend of an asset price. An asset can be highly volatile and may still provide strong growth over the long term. This is particularly true of the equity market.
The JSE All Share Index broke its long-term trend and fell from 57 900 to 37 900 points in March 2020. Had an investor panicked and exited the market at that time, he/she would have realised substantial losses in the process. Those staying the course would have seen the index recover from April and build its way back to pre-pandemic levels by July. The index breached 67 000 points in February 2021.
Staying invested in the market for the long term has historically yielded good results. Long-term goals need to be aligned to the strategy of staying invested, as staying invested allows investments and savings to ride out short-term market volatility.
Why the need for emergency funds?
One thing that COVID-19 has taught us is that unpredictable events can and will occur. Staying invested requires funds to be left for the correct time period to perform. Should cash be required in an emergency, these long-term vehicles should not be cashed out. An emergency fund must be accessible to long-term savers and investors so that long-term investments and savings do not need to be cashed out when a crisis occurs. Building up three months' worth of expenses and utilising a short-term saving vehicle to do so is a sound strategy in protecting your long-term vehicles when cash is required immediately.
Pensions, investment vehicles or both?
For most, saving for retirement is done through a company pension fund. While this is an effective savings method, it may not be accessible for everyone and you may need to supplement such a pension fund with additional retirement savings. A retirement annuity fund (RAF) is a long-term retirement vehicle bearing similar characteristics to a pension fund. The main difference is that this fund cannot be paid out in a lump sum like a pension fund. When changing jobs, savers have the option of reinvesting their pensions with a new company or receiving a lump sum. For some, that new car or home renovation seems more important at the time, but that means that their nest egg will be significantly smaller, and future retirement contributions must make up a lot of lost ground.
Estimates show you will require roughly 75% of your current monthly income to retire comfortably and maintain the lifestyle you are used to. Requiring this for 20 years plus will require years of consistent contributions. Cashing out pensions to fund short-term expenses might seem like a good idea at the time, but the consequence will be that a higher percentage of monthly income will be required to fund the gap, or alternatively not having enough funds put away to retire comfortably. When moving jobs, funds should be reinvested into another pension fund or an RAF.
These vehicles are not mutually exclusive; both can be utilised by savers for retirement. An RAF is a fantastic vehicle for wealth preservation as only up to a third of the fund can be withdrawn as a lump sum when reaching 55 years of age, with the balance paid out in a monthly living annuity. Having both options allows you to contribute more savings to retirement while being able to deduct contributions made for tax purposes, up to the contribution limit set out by the South African Revenue Service.
Final thoughts
Investing and saving for retirement consistently and through multiple vehicles allows compounding to take place. Having a healthy balance of both investments and savings is crucial in retiring comfortably. While starting early is the best strategy, it is never too late to start saving and investing for the long term.
