AUTHOR: Regard Budler, Head of Product Solutions at Momentum Corporate
As life expectancies increase, the risk of outliving retirement income rises. Many South Africans face a bleak retirement because they are either not contributing enough towards their retirement, not preserving their savings when they change jobs, or are following an inappropriate investment strategy.
However, Momentum Corporate’s recent research shows that retirement is seen very differently by the different generations. Older generations still strive to have enough saved for retirement, while younger generations see retirement from a full time job not as the end of their careers, but rather as a transition into a different phase of their lives where they will earn their income – not from a formal salary but through different means like starting a small business or to rely on passive income or their families.
Although this may be the latest trend in retirement savings, the reality is still that the average replacement ratios of members belonging to retirement funds are very low.
Most individuals, regardless of their view of retirement, will face serious problems when they retire, unless financial advisers, employers, trustees and individuals themselves focus on the key levers to improve the probability that members will reach their desired retirement outcomes.
One way of increasing retirement savings over the long-term is to invest in portfolios that target returns that are well above inflation. Aggressive portfolios typically target returns in the region of inflation plus 7% over rolling 6 and 7 year periods. Our modelling shows it’s necessary to invest a significant portion of the portfolio in growth asset classes (i.e. local and global equities and property) in an attempt to outperform the targeted return. With this, however, comes learning to live with the short-term volatility associated with these asset classes.
While these growth assets may be volatile, they are an essential part of the asset mix needed to deliver inflation-beating returns over the long-term. Historical analysis shows they usually outperform inflation by an acceptable margin over the longer term. However, over the short-term, aggressively-constructed portfolios can deliver low or even negative returns.
Members invested in these types of portfolios need to take comfort in the fact that they are likely to recover and deliver inflation-beating returns over the longer term. However members often overreact and make emotional decisions to move their assets to more conservative portfolios. Financial advisers play a key role in helping investors to navigate and to avoid hasty portfolio changes that may reduce the probability of them reaching their long-term retirement goals.
Well qualified financial advice is critical in helping members to understand the implications of moving their assets between portfolios when disappointed by short-term returns. If they stay invested through the cycle, there is a good chance of returns recovering. However, selling means that they will realise the underperformance and that there is no chance the loss will be recouped. Plus, selling and ‘locking in losses’ means having to re-enter the market with an investment that has decreased in value.
An outcome-based investment approach also helps members reach their long-term retirement goals. The FundsAtWork Umbrella Funds offer members a wide range of investment portfolios, including a number of portfolios which follow Momentum’s outcome-based investing methodology.
Outcome-based investing doesn’t focus only on the inflation-plus targets of the various portfolios but also on the volatility of the journey. Solutions are crafted by considering members’ needs and risk tolerance, defining a goal (usually an inflation-plus objective) and an appropriate time-frame to achieve the objective. The approach improves the probability of the portfolio delivering on its ultimate objective and members achieving their desired retirement outcome.
Given the magnitude of the current retirement savings gap, increasing replacement ratios to achieve desired retirement outcomes may appear daunting. However, smart re-engineering which builds on outcomes-based investing can improve replacement ratios significantly and improve the probability of reaching the desired outcomes and reduce the risk of South Africans outliving their retirement income given that members save for extended periods and they adequately contribute towards their retirement savings.