Are you in­vest­ing enough for re­tire­ment?

Finweek English Edition - - Fundfocus Investec Asset Management - By age Paul Hutchin­son By Paul Hutchin­son

aSav­ing – and sav­ing enough – for re­tire­ment is crit­i­cal. A re­cent study by In­vestec As­set Man­age­ment shows that key to this process is choos­ing the right level of start­ing in­come in or­der to en­sure you don’t come up short later.

key ques­tion in any fi­nan­cial plan­ning exercise is “How much do I need to save so that I can com­fort­ably main­tain my stan­dard of liv­ing in re­tire­ment?” Ad­dress­ing this cor­rectly and timeously is crit­i­cal as pen­sion­ers have dif­fer­ent needs (a reg­u­lar in­come that ide­ally in­creases with inflation over time) and dif­fer­ent risks (run­ning out of money, i.e. liv­ing too long) to other types of in­vestors.

There are also im­por­tant psy­cho­log­i­cal as­pects that must be con­sid­ered. Many re­tirees will find it dif­fi­cult to sur­vive on a state pen­sion, go back to work or be sup­ported by their fam­ily.

In­vestec As­set Man­age­ment re­cently com­pleted an in-depth study into how in­vestors should ap­proach their re­tire­ment in­come pro­vi­sion. One con­clu­sion high­lights that choos­ing the right level of start­ing in­come is key to in­vestors man­ag­ing their risk of run­ning out of money. In short, a re­tiree should elect a start­ing in­come level of no more than 5% of their re­tire­ment cap­i­tal.

With this start­ing in­come level of 5% of re­tire­ment cap­i­tal as your stan­dard, we can cal­cu­late that you re­quire a cap­i­tal lump sum equal to 20 times your fi­nal salary to in­vest in an in­come­pro­duc­ing an­nu­ity on re­tire­ment. This is the amount re­quired to gen­er­ate an in­come equal to 100% of your fi­nal salary, post-re­tire­ment (i.e. a re­place­ment ra­tio equiv­a­lent of 100%). Draw­ing no more than 5% is con­sid­ered likely to pro­vide you with an inflation-ad­justed in­come for 30 years, en­sur­ing a com­fort­able re­tire­ment. Any cap­i­tal lump sum of less than 20 times will re­sult in a lower start­ing in­come (a lower re­place­ment ra­tio) than your fi­nal salary and there­fore you would need to re­duce your monthly ex­pen­di­ture ac­cord­ingly.

While know­ing how much you re­quire is crit­i­cal, so too is know­ing where you are on the path to this lump sum. Ar­riv­ing at a suf­fi­cient re­tire­ment pot is a jour­ney that takes a full work­ing life­time, as the fol­low­ing for­mu­las il­lus­trate. The im­pact of de­lay is con­sid­er­able:

Start­ing at 20: 15% of pre-tax salary X 40 years of em­ploy­ment

= 20 times in­come re­quired at age 60

In this ex­am­ple, some­one starts work­ing at age 20 and saves 15% of their pre-tax salary ev­ery month for their en­tire work­ing ca­reer. And, in the event they change jobs, they pre­serve their ex­ist­ing re­tire­ment sav­ings. This proverbial uni­corn is one of the mi­nor­ity who can re­tire com­fort­ably at age 60.

Start­ing 10 years later: 30% of pre-tax salary X 30 years of em­ploy­ment = 20 times in­come re­quired at age 60

A more re­al­is­tic ex­am­ple is where some­one does not start pro­vid­ing for re­tire­ment from age 20 or does not pre­serve their re­tire­ment ben­e­fits when they change jobs in the first 10 years. They are then re­quired to save twice as much of their pre-tax salary for the shorter 30-year pe­riod to achieve the same out­come (or re­tire at 70).

Start­ing 20 years later: 60% of pre-tax salary X 20 years of

The chart above shows what mul­ti­ple of your cur­rent an­nual salary you need to have saved at any age be­tween 20 and 60 to en­sure a re­place­ment ra­tio equal to 100%. We have also shown the mul­ti­ples re­quired for a 75% re­place­ment ra­tio by way of com­par­i­son.

A 75% re­place­ment ra­tio may suf­fice for many re­tirees, de­pend­ing on lifestyle choices and fi­nan­cial obli­ga­tions. Once re­tired, re­tirees do not typ­i­cally con­trib­ute to a re­tire­ment fund any­more. Trans­port and cloth­ing costs could come down, and they may be debt free, with fi­nan­cially in­de­pen­dent chil­dren.

So, by age 40, you should have accumulated re­tire­ment sav­ings of ap­prox­i­mately five times your an­nual salary if you are tar­get­ing a re­place­ment ra­tio of 100%. An­other in­ter­est­ing ob­ser­va­tion of this chart is the ac­cel­er­a­tion of cap­i­tal val­ues in later years, a clear il­lus­tra­tion of com­pound­ing ben­e­fits. Note, while it took 20 years to ac­cu­mu­late sav­ings of five times your salary, it takes only a fur­ther 10 years for your accumulated sav­ings to dou­ble to 10 times, and then only an­other 10 years for your accumulated sav­ings to dou­ble yet again and reach the mag­i­cal 20 times!

The value of ac­tive man­age­ment should not be over­looked. A key as­sump­tion in our cal­cu­la­tions is a port­fo­lio re­turn of 7% above inflation, which joins forces with com­pound in­ter­est and your con­tri­bu­tions to de­liver your lump sum avail­able at re­tire­ment. With this re­turn, 40 years of sav­ing 15% of your pre-tax in­come should see you re­tire com­fort­ably, draw­ing 5% per an­num from your sav­ings. How­ever, if re­turns are 2% higher, at CPI + 9%, you’ll have saved 35 times your fi­nal salary. ■

is sales man­ager at In­vestec As­set Man­age­ment.

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