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Retirement: How to Protect Capital in Your Golden Years

Fairytale Ending: But this can only happen if you save your money before retirement and grow your capital when your working days are over

During your working years you should, ideally, be building up your retirement capital by making continuous contributions from your earnings.

Once you retire, that cash flow will almost certainly reverse: you will draw your income from that capital for the rest of your life.

This can be scary, because now we live for longer thanks to modern medicine – and while trying to stretch our retirement savings, stock markets can plunge, inflation can erode that capital and choosing the wrong asset class can mean the difference between a comfortable or an uncomfortable standard of living.

So what’s the best way to protect your capital?

Lourens Coetzee, investment professional at Marriott Asset Management, said employees should save as much as possible in their working years to build a big enough capital base to live off the income produced after retirement.

“This philosophy of spending only the income and not the capital will ensure your investment will last through your retirement years,” Coetzee said.

“Most retirees are stuck in a position where they haven’t saved enough and are drawing too much income from their investment. The more income you draw from an investment, the less that income can grow … growth in income in line with inflation is necessary to maintain the purchasing power of your income stream over time.”

Coetzee said that of the four main asset classes – equities, property, bonds and cash – equities offered the least income, but the most potential capital growth.

“By contrast, property offers income growth close to inflation, while bonds and cash do not grow income.” Coetzee said that for an investor needing a 6% income level, it is possible today to reach that by investing in a portfolio of 40% equities and 60% bonds.

“Through bonds [income funds] you’re likely to get a yield of 8% and a 3% yield from equities, but while your income from those bonds may not grow, the income from equities may grow by 9% to 10%. This asset allocation will create an overall portfolio that will deliver the initial 6% income level required, and grow that income at approximately 4% per year … to help keep up with inflation,” Coetzee said.

Brian Butchart, director and senior financial planner at Brenthurst Wealth Management, said that once on pension, investors became responsible for investing their own retirement capital – and the most popular way of doing so was through a living annuity. But pensioners were often terrified of managing this capital themselves.

Butchart said: “You can invest your post-retirement capital from which your income will be generated into any asset class available to South African investors – including offshore investments.

“We have come across many instances where investors have been trying to grow their capital – and hence their future income – as rapidly as possible by investing in high-risk funds. In most cases these attempts have been disastrous, particularly over the past few years.

“At the other end of the spectrum we find nervous investors not wanting to take on any risk at all. Instead, they opt to invest their living annuity capital into money-market or high-income funds, which have no risk attached to the capital at all – but … over the medium to long term, money-market funds are not ideal as they do not offer the investor any chance of capital growth.”

Butchart said interest rates were at all-time lows and inflation was running at levels above the average money-market return, resulting in negative real returns after withdrawals.

“In terms of current legislation, an investor in a living annuity has to draw an income of between 2.5% and 17.5% of capital. With interest rates as low as they are and the average withdrawal rate between 6% and 8%, this means that capital in a money-market account earning less than 6% will deplete capital over time. Deduct from these gross returns the cost to the investment house and adviser, anything between 1% and 2%, as well as inflation and the investor is left with substantial negative real returns.

“Most strategies (25%, 50% or 75% equities) can comfortably accommodate a withdrawal rate of up to 4% per annum. A higher equity exposure improves one’s odds of not running out of capital to an acceptable level. For those investors requiring income levels of 8% or more, there is limited certainty – especially for females, who tend to live longer than their male counterparts – even at maximum equity exposure,” said Butchart.

“Owners of living annuities will have to accept some degree of risk if they want any chance at all of growing capital above their withdrawal levels and ensuring that income levels do not deplete capital over time. A totally risk-free approach is not going to crack it.

“A well-managed living annuity portfolio, reassessed twice yearly, should never run out of cash and it leaves capital and/or income for a second generation,” he said.

Author: Brendan Peacock
Source: Times Live

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