De-risking at retirement costs SA investors 28 months of retirement savings

By: Pieter Hugo, Chief Client and Distribution Officer at M&G Investments

Pieter Hugo, Chief Client and Distribution Officer at M&G Investments

While it may be common to consider “safe” investments like cash and bonds as the best choices for a retirement portfolio, asset allocation decisions for your retirement savings should rather be based on the best combination of assets to help you achieve your retirement goals in the time you have left to save, with the least possible risk. While cash appears to be a “safe” option by providing returns at a more consistent level than riskier assets like equity and listed property, you are likely to be foregoing the potential upside offered by these growth assets in helping to achieve your retirement goals. Consistently maintaining the appropriate balance between risk and return potential is critical in a retirement portfolio.

When investors opt for extra cash and de-risk their portfolios, typically they are trying to avoid losses during periods of high market uncertainty. However, when they switch out of equity it can also result in missing out on the best days in the equity market. This can affect the long-term return potential of their investment.

Historical data shows that maintaining exposure to an appropriate asset allocation and not switching will ultimately reduce portfolio volatility and boost returns, compared to de-risking. Taking the patient approach is particularly necessary for retirement investing when there is a longer investment term (generally 30-40 years or more in a working career).

The effects of de-risking at the point of retirement can also significantly impact retirement outcomes. Recent research by M&G on the largest LISPs in South Africa revealed a drop-off in returns for investors who de-risk from high equity balanced funds to less risky solutions, leaving a retirement shortfall.

To quantify the impact of de-risking, we analysed the historic returns since inception of pre- and post-retirement books (in other words, the underlying investments according to ASISA categories of retirement annuities [RAs] and living annuities [LAs]) of a few of South African’s largest LISPs. In RAs, just over half (54%) of the investments were in multi-asset high-equity portfolios, but at the point of retirement, the allocation to these balanced funds in LAs effectively halves to only 27%, moving to lower-risk categories such as multi-asset medium- and low-equity funds or offshore.

Based on this data, our calculation revealed a total expected real return for the pre-retirement RA book of 4.85% p.a. versus 4.05% p.a. for the LA book, which is a 0.8% p.a. difference in returns. This means that if investors de-risk at retirement, their return is likely to be 0.8% p.a. lower than if they had not de-risked. On face value, 0.8% may not sound like much, but when it is compounded over time, the effect over the long term is highly detrimental: over time retirees will deplete their retirement capital 28 months earlier than the scenario where they did not de-risk. So, retirees who are worried about outliving their retirement savings shouldn’t be afraid to keep a reasonable allocation to equities in their portfolios, such as that of a balanced fund, at up to 75%.

Since no one can control the markets, investors should focus on what is within their control, such as fund selection and asset allocation. Targeting inflation-beating returns at lower levels of volatility can help improve your possible retirement outcomes.

1 – https://www.cfainstitute.org/-/media/documents/study-session/2022-l3-studysessions-combined.pdf

2 – https://www.asisa.org.za/media-releases/local-cis-industry-statistics-reflect-a-tough-second-quarter-for-investors/

Tagged under:

Visit the official COVID-19 government website to stay informed: sacoronavirus.co.za