03 Jun Retirement planning and inflation in South Africa
Investment and retirement planning is a fascinating, diverse profession because every investor has their unique set of financial circumstances, attitudes and issues. However, we find there are some beliefs or attitudes that a number of retirees have in common.
Retirement planning to leave a legacy
One of the more common attitudes (or hopes!) is an investor’s desire to leave saved capital ‘untouched’ upon retirement. Their objective is to live solely off the investment returns, usually in the form of dividends and interest, and to leave the capital invested forever. The underlying motivator in most cases is to leave the capital behind for future generations. This may be a worthy goal, but is it realistic?
What retirement planning approach do they foresee?
The thinking behind such an approach is very common, and follows a standard pattern. A couple will first estimate what their annual retirement requirements are, for example R240,000. Then, using an assumed investment rate of return they will calculate the capital required to generate the desired return.
They may assume that an investment return of 8% p.a. (after fees and costs) is reasonable and sustainable in today’s investment environment and thus an initial capital amount of R3,000,000 would produce their requirements.
If this amount of capital was available, they would assume that it would be feasible to retire on this amount and leave their capital successfully ‘untouched’.
There is, however, a major flaw in their approach
The ongoing effect of inflation has been ignored in their selected retirement planning investment strategy. Even though inflation has come down significantly over the past few years, it is still most investor’s number one enemy. It can still erode wealth over time. As a result, such a strategy is known among financial planners as ‘investing oneself poor’ – clearly not a desirable outcome.
So, how does this particular retirement planning strategy fall short?
In the example above, assuming an inflation rate of 6%, the retiree’s annual requirements in the second year of retirement will increase to R254,500. This increase may in fact go largely unnoticed as it is not significant, and in addition, it is diluted over the course of a year.
The downward spiral effect of ongoing inflation
What is very important to realise is that the underlying capital will now not produce quite enough returns to fund the increased annual requirement. The couple will need to dip into capital slightly. Of course this process will repeat itself in future years, but at an escalating rate; a lower capital amount will produce lower returns, which in turn requires higher draws on their capital. It’s certainly a vicious cycle that they would prefer to avoid.
Realistic retirement planning could avoid this vicious cycle
In our example above, the R3,000,000 capital will sustain the retiree’s annual lifestyle requirement of R240,000 (increasing with inflation) for little more than 15 years! And at that point, there will be nothing left.
What should retirement financial planning in South Africa take into account?
Calculating sufficient retirement capital must always take into account the ongoing effect of inflation. In cases where the capital is not available, some difficult decisions may have to be made. For example, starting retirement may need to be delayed to build up additional capital reserves. Alternatively, overall retirement spending expectations may need to be down-scaled. Investors in this position might need to consider taking on more investment risk to achieve better investment returns. However, such a decision should only be taken after in-depth analysis of the possible consequences of increased investment risk.
Next step? It’s never too late to start retirement planning
A proactive approach puts you in the driver’s seat, which can save you from what may be pointless worrying. A professional investment planner can ensure that you have a realistic financial plan to achieve your retirement goals.
Contact us at Netto Invest and ask our CERTIFIED FINANCIAL PLANNER® professionals to shine a light on your retirement planning and inflation situation.