South African investors’ appetite for growth assets has certainly been impacted by the poor performance of the domestic equity and property markets over the past few years.
A comparison of the (ASISA) South African Multi-asset High Equity and -Income categories’ net flow history clearly illustrates the de-risking trend that has transpired as a result.
The multi-asset high equity category experienced net outflows for the first time in seventeen years in 2019, while the multi-asset income category had a record year of net inflows of more than three times that of its previous high in 2012. It was also the first year since 2008 that the multi-asset income category’s net flow was greater than that of the multi-asset high equity category.
Although de-risking may have been a suitable change for some investors, research shows that a lack of exposure to growth assets significantly reduces the likelihood of success for retired investors drawing an income from their investments. In other words, too little exposure to growth assets can materially weaken retirees ability to sustain their income and other financial needs throughout retirement.
There are various factors that impact the likelihood of success and the role each play is best described through some real-life examples.
Case study: The drivers of living annuity success
The starting point of your retirement journey is how much you were able to save for retirement. As illustrated in the table below, the value of your savings determines the monthly income you can afford at a sustainable drawdown rate of 5% or less, or alternatively the drawdown rate you need to select to fund your income needs.
The next step is to determine an appropriate asset allocation for your investment. Put differently, what is the ideal level of exposure to growth assets (like equity and listed property), income assets (like cash and bonds) and direct foreign assets? The most widely used living annuity investment solutions can broadly be split into three buckets and the assumed long-term asset allocation for each is summarised below:
- Income: 5% equity exposure; 95% income exposure; 10% total foreign exposure
- Low Equity: 35% equity exposure; 65% income exposure; 22% total foreign exposure
- High Equity: 65% equity exposure; 35% income exposure; 25% total foreign exposure
To better understand the drivers of success, let’s look at the potential outcomes for an investor retiring with R 3 million, investing in each of the above listed fund groups and drawing an income across a range of various drawdown rates.
The tables above reflect the likelihood of success for the various retirement journeys, using The Nedgroup Investments Big Picture App which is based on monthly market performance data since 1926. In all scenarios above monthly income has been annually adjusted for inflation and investment-related fees of 1.5% per year have been accounted for. A few important observations:
- At any given drawdown rate, the likelihood of success increases as you increase the exposure to equity and move from left to right (from Income to High Equity);
- At any given investment solution bucket, the likelihood of success decreases materially with an increase in drawdown rate;
- At any given drawdown rate and investment solution bucket, the likelihood of success decreases as the time horizon increases.
These results clearly illustrate that the main detractors from success are:
- A low exposure to growth assets, i.e. investing solely in Income or Low Equity solutions,
- A drawdown rate greater than 5%, and
- Starting to draw an income at a younger age, increasing your expected retirement horizon.
Another factor within your control is how much you pay for your investments on an annual basis. As displayed below, reducing your overall fees has a material impact on the longevity of your capital - thanks to the power of compounding – as every bit you save on fees, remains invested in your portfolio.
2020 has reminded us just how volatile markets can be and certainly tempted many investors to switch from equity to cash. It also highlighted how costly reacting emotionally to short-term market volatility can be. Investors who de-risked after the market collapse in March would have missed out on the strong equity recovery, both domestically and globally that occurred in April and May.
In times like these, your financial advisor can add material value by helping you manage the uncertainty and ensure you implement the important elements of retirement planning, some of which are listed below:
- Start saving for retirement as early as possible;
- Consider delaying your retirement date, if you can;
- Be frugal in retirement and only draw down what you need;
- Look for ways to supplement your income in retirement;
- Invest in a diversified portfolio with enough exposure to growth assets;
- Be aware of your annual investment charges;
- And most importantly, stick to the plan!