Your most valuable asset
REGULAR STREAM OF INCOME IN LINE WITH LIFESTYLE
A43-year-old man – in seemingly perfect health – sits on a couch in his living room with his wife and daughter. “Gary can get R2 million in life cover and R1 million in disability cover for just R700 a month,” the advertisement reads.
There is something about a large sum of money that gets people much more excited than the idea of a steady monthly income. Why do investors favour a lump sum? It may be because “wealth” is generally associated with a lot of assets or a large pool of money.
Unfortunately, most people struggle to manage a significant pot of money – particularly if they need to live off it for a long time.
As the former chief executive of a large asset manager succinctly puts it: “Most mere mortals are used to a monthly income. Large capital amounts get us all confused.”
Human beings overestimate the value of a lump sum, adds Brad Toerien, CEO of FMI.
Research FMI recently conducted suggests that if offered a choice of R1 million or a guaranteed income of R10 000 a month for the rest of their lives, most people will prefer R1 million, even though the second option is worth significantly more.
The preference for a lump sum may also be because financial planning has historically been done this way and that people prefer to have access to a large pot of money.
“But in reality, what we work for is a lifestyle and to protect that you need a regular stream of income,” he says.
The preference for lump sum benefits – in retirement and with regard to injury, illness or death – may also be related to a distrust of institutions.
People may argue that if the money is in their bank account, it is theirs to use as they see fit, but if a financial institution or government has to provide them with an income, their fortunes are in a third party’s hands.
From a financial planning perspective, there has been a growing realisation that people’s greatest asset is their ability to earn an income throughout their lifetime.
While most defined contribution funds lack a clear income-goal focus for individual members, commentators are increasingly highlighting the need to focus on income instead.
It is perhaps time to question whether it is appropriate to place so much emphasis on saving towards a large pot of money at retirement or the importance of taking up a large lump sum death, critical illness or disability benefit.
While there is undoubtedly value in all of these lump sum benefits (people will surely be better off having a lump sum retirement or risk benefit than not having it), the value of a lump sum is significantly impeded if investors don’t also have the ability to earn a monthly income in line with their living standards.