Research Articles

Help me too! I’m really depleting my post-retirement income sources too soon – what corrective measures can be taken?

This article is an expansion of an article, titled: “Help! I’m running the risk of depleting my retirement income sources too soon”, published earlier that investigated the effects of various financial measures to enhance the long-term cash flow prospects for retirees. The same methodology is being followed, but a somewhat more ominous financial position of a retiree is sketched as the baseline case.

Source:  Corrective measures_2.0


Research Articles

Help! I’m running the risk of depleting my post-retirement income sources too soon – what corrective measures can be taken?

Consider the scenario where a retiree, say, between the ages of 70 -75, is withdrawing relatively large amounts from her living annuity (ILLA) while her reasonable life expectancy is another 15 – 20 years out. Unless the retiree will receive an unexpected windfall, fantastic investment returns, or manage a drastic reduction in living expenses going forward, it is very likely that the retiree will experience severe cash flow constraints ten years and more from now.

Source: Corrective measures

Research Articles

To RA or TFSA – which one is better, when? (updated version)

An evaluation of investing in a retirement annuity product versus a tax-free savings account – which investment product yields the highest possible value for money considering various marginal income tax rates and investment horizons?

Source: To RA or TFSA



Research Articles

The sustainability of retirement plans measured against historical market returns

Assumptions is at the core of retirement planning – one is dealing with the unknown future and one tries to project how this path may unfold, given the current set of facts and conditions at hand.  That process, however, may be flawed in some respects. We are biased towards recent events and financial history, and not considering “all of history”. If you like, we apply selective memory in the formulation of core assumptions, very often those make-or-break factors in the equation.

For example, we may project an individual’s retirement plan is on track based on an assumption of an investment return of 5% per annum after inflation, because that has been the historical precedent over the past ten to twenty years. But what if one will only realise a 3% return per annum, after inflation in the next ten or twenty years? More than likely, the comfort of “ticking all the boxes” will disappear in such lower return environments. What other tools have you in the shed to prevent or mitigate such unpleasant surprises?

This paper evaluates some key factors in the make-or-break of retirement planning, namely expected market returns, investment portfolio composition (asset allocation), sequence-of-return risk, drawdown rates, and the management and adjustments of drawdowns during the post-retirement phase.

Source: Sustainability_historical market returns

Research Articles

Contributions towards a retirement annuity or tax-free savings account: Which one is better, when?

Research Articles, The Short Series on Retirement Planning

Income coverage and the post-retirement period (updated version)

Retirees are mostly concerned whether they have sufficient retirement capital to fund their post-retirement income needs for some unknown period in the future.  Hence, various rules of thumb exist in the retirement industry to guide retirees in their decision-making. For example, aiming to have retirement capital available between 15 to 20 times your annual income needs at retirement. Or, for every R4,000 per month income required, one should have R1 million in capital available – meaning R5 million in retirement capital to meet R20,000 per month.  These rules assume that income needs will adjust with inflation over time.

While these rules are very handy, it does not solve the problem if one’s retirement portfolio value does not meet these retirement capital targets. The situation may arise because of many “self-made” causes; inadequate contributions, not re-investing the proceeds upon resignation from a previous employer’s retirement fund, irresponsible investment choices, etc. Moreover, one could have done all the right things “by the book” leading up to retirement, but market returns were simply poor or subdued for several years before reaching retirement age.  Thus, exogenous events led to a situation where capital targets are not met.

But around retirement age, one has limited options of “fixing” the capital shortfall. Maybe one can extent your term of contract with your employer for another year or two, but one might have health issues not making it feasible; also, one’s skills set may be redundant, or simply, the situation at work is emotionally unbearable – “you have had enough” of office politics, daily commuting, stress, etcetera.

In such scenarios, does it mean one can’t retire as planned, yes, likely, but how much does the “capital shortfall” affect the long-term sustainability of one’s retirement plan? What corrective measures should be taken now to address insufficient retirement income at some stage in the future?

An alternative approach is to focus on the income ability of one’s retirement fund. What is the current income (interest, dividends, distributions) yielded by one’s retirement fund and how closely does it match your income needs? For example, say your current fund at retirement is worth R5 million and is invested in a range of equities, commercial property investments (known as REITs), and interest-bearing investments that over the past year yielded a total income of R200,000 (income yield = 4%). Compare this with your income need of say R300,000, thus the income from your retirement portfolio matches 67% of your annual income needs. This could be referred to as the “income coverage” of one’s retirement fund.  Given that “coverage”, and with proper portfolio management, known as an “income focus” approach, how many years will the retirement plan be sustainable going forward? [1]

In the “income focus” approach of retirement planning the capital amount per se is secondary. [2]  The basic idea is to focus on the sustainable, income yielding ability of your retirement fund and to align it with your income needs. Note, however, I am not referring to the maximising of income from the portfolio, and thus forsaking any further capital growth over time, but allocating it in such a manner where income is sustainable and growing with inflation-adjusted needs of the retiree for many years to come. Thus, I’m not considering investments that only pay interest with no underlying capital appreciation, typically like call and term deposits.

The “income focus” approach implies a re-organising of your portfolio composition, and investing predominantly in dividend-growing stocks and REITs.  An important characteristic of dividend-paying companies is that dividends tend to be “sticky” over time, i.e. companies do not reduce easily their dividend payments to shareholders/investors, bar an economic crisis or a serious company-specific issue, and usually grow their dividends in line with their economic performance, often well above the inflation rate.  Many investment portfolios, however, are geared towards maximising capital growth over time, but with little attention paid to actively managing the income yield. In such portfolios, one will find typically investments in businesses that have vast growth potential, or companies busy expanding new growth opportunities, but pay relatively little, if any, dividends. For retirees, however, that have a specific income need today, such investments won’t suffice really.

[1] Bridge Asset Management (formerly known as Grindrod Asset Management) is an active proponent of the income focus approach towards investing for retirement. Please refer to their website for detailed information about their investment philosophies and processes.

[2] It does not mean capital values or growth are not important, but the main emphasis is to manage the investment portfolio to yield a reliable, predictable growing income stream over time.


Source: Income_Coverage

Research Articles

Portfolio returns and the effect thereof on meeting desired retirement income targets

For retirement planning purposes we often use return assumptions based on historical market index return data, but at the same time ignoring the prospects of adding additional returns to your portfolio returns without a corresponding increase in the volatility or uncertainty thereof. Typically, this can be done through active management of your investment portfolio, i.e. employing active managers to manage your investment portfolio and via good stock selection and market timing processes it is possible to add additional return beyond ordinary market returns, sometimes even at lower volatility than the market index return.

However, let me state at the onset that the value-add of active management is nothing but certain – empirical evidence points to the fact that most active managers under-perform market benchmark returns over any given investment period. Thus, it is not really like 50% of active managers are doing better than the market benchmarks, it is more like 10-20% of active managers are outperforming. Therefore, it is sensible to use market return assumptions for retirement planning purposes, rather than relying on significant outperformance by active investment management.

Notwithstanding, active investment managers have been around “forever”, while low-cost investment funds that specifically track market returns across asset classes are relatively a new addition to investment management, otherwise known as passive index trackers. In recent times, low-cost, passive multi-asset solutions have come to the fore as an investment option for individual investors. These evolving trends, undoubtedly, helped to reduce the cost of active investment management too as both strategies vie for individual investors’ attention. Thus a “win-win” situation emanated for investors as both investment strategies can be employed at much reduced costs than maybe 5-10 years ago.

The purpose of this short article is to illustrate the differences active portfolio management could make to the outcome of your retirement plan, both positive and negative effects.

Source: Portfolio returns_retirement income targets