As the volatile investment markets are exacerbated by the coronavirus pandemic, it is appropriate that we emphasize the “return risk sequence” problem. This is the long-term negative effect for retired investors if your retirement capital falls immediately after you retire and you have a steady income.
The decline in investment will result in a larger capital withdrawal than in growth, which means that in the coming years a larger part of the capital will have to be withdrawn in order to achieve the same level of income. The end result is running out of your retirement savings in less time.
This scenario is best illustrated with an example from the coronation:
Consider two portfolios, both of which have an average annual return of 11% with a drawdown rate of 7% per year. Portfolio One’s returns for the first three years are: 14%, 29% and -7%. Portfolio Two’s returns for the first three years are: -7%, 14% and 29%. Portfolio 1 will have sustainable income for 24 years and Portfolio 2 will have sustainable income for 16 years. This simple example shows that if your retirement date coincides with an adverse market environment, the effects on accumulated savings can be devastating.
This “sequence of return risk” is a pure function of mathematics and “bad luck”. However, you can mitigate this long-term negative effect by making sure that you have an appropriately conservatively structured investment portfolio when you retire.
You need the right balance between income and growth wealth to achieve post-inflation (long-term) growth and short-term capital preservation.
In the current low-inflation global environment, investors need to moderate their return expectations and ensure that they are not withdrawing more from their live pensions than can be sustained. The worldwide accepted drawdown rate is no more than 5% of the invested capital per year in order to preserve the savings over the long term.
A weak SA economy poses challenges for investors
Although global inflation is expected to remain low for a number of years, higher long-term inflation in South Africa poses a risk due to the country’s deteriorating finances. When the economy struggles to grow and public debt spins out of control, foreign funding becomes more necessary come at a far higher price, weaken the rand and boost inflation.
It is therefore imperative that your investment portfolio strategy includes an edge hedge component that matches your personal risk profile. Talk to one of our portfolio managers to support you in implementing the strategy that is right for you.
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