Retirement Planning – Income And Growth Challenge

retirementIndividuals at or near retirement face the challenge of ensuring a sustainable standard of living by balancing the needs of today with those of the future thereby investing for both immediate income and long-term growth.1. Plan for higher inflation

Given lower return expectations from all asset classes going forward, it is believed that investors with insufficient growth assets (equities) in their portfolio might find themselves vulnerable later.

This view stems from the fact that as a result of the recent superior performance from all asset classes, exposure to growth assets was not required to achieve targeted returns. This will not be the case going forward.
Below we summarise the attached article from Coronation Fund Managers which highlights the considerations that investors with income and growth needs should take into account to ensure that their retirement planning is appropriately prudent.

1. Plan for higher inflation

Headline inflation, as quoted in the media, is based on the “average” South African’s basket of goods. Older individuals in the higher income categories often have disproportionate exposure to healthcare, municipal rates (10% plus), water (10% plus) and electricity (20% plus) – all running at inflation numbers well above the current headline number.

The prudent investor and planner will make provision for a significantly higher inflation rate than the current rate of 3.7%.

2. Plan for lower returns

The growth momentum of the global economy has started to slow with the general consensus that world economic growth will remain below par for longer than in previous cycles.

Central banks will keep interest rates low for as long as possible but the risk of low rates for an extended period of time and printing money will ultimately be inflation. Growth assets are the most reliable means of protecting your one’s capital from the eroding effects of inflation.

Investors in local assets have been handsomely rewarded over the past 10 years, however using the past decade as a guide to future returns is a poor basis for retirement planning as we believe that a reversion to long-term average growth rates is more likely.

Coronation Fund Managers believes that to explain this view one needs to examine the source of the past 10 years’ returns.
– Company earnings have grown significantly faster than South Africa’s overall GDP (6% after inflation for the All Share Index versus 3.6% for the economy) as a result of a decline in tax rates, muted real wage growth and expansion abroad. While equities have enjoyed a positive rerating of 1% p.a. over the past 10 years, the impact of earnings growth on the asset class’s total return has been far greater. This level of earnings growth is unsustainable, thereby lowering returns over the next 10 years.

10-YEAR FORECAST FOR LOCAL AND OFFSHORE ASSET CLASSES
PAST 10 YEARS 10-YR FORECAST
GROWTH ASSEST
 – Local equity 17.0% 10 – 12%
 – Global equity 2.3% 13 – 15%
 – Property 23.2% 9 – 10%
INCOME ASSETS
 – Bonds 13.2% 8 – %
 – Cash 10.3% 8 – 9%
INFLATION 6.8% 6% (+?)

 3. Plan to live longer

As unsettling as it is to think of one’s own mortality, most people underestimate the investment time horizon that needs to be planned for. As a result of advances in healthcare technology and improvements in nutrition, people are living longer.

A female retiring at 65 can expect to live a further 20 years; a male 17 years. Therefore planning for a 25 – 30 years would be prudent especially given that at a 6% inflation rate, you will require almost 6 times the level of income at the ends of your planning horizon.

4. What are the implications for retirement planning?

The prudent planner’s response to the backdrop painted above will include moderating income drawdown rates and ensuring that portfolios are adequately exposed to growth assets – click here for more information.

Given Coronation’s expectation for lower returns, we do not believe that initial income rates above 6% – 7% will be sustainable for most retirees (and then only from a portfolio with adequate exposure to growth assets.)

 

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