The retirement system’s unfair bet and how you can improve the outcome: Fred van der Vyfer, Old Mutual

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Two equally responsible South Africans can do everything right, save diligently, keep their costs down, earn a decent long-term return, and still retire with very different outcomes. Fred van der Vyfer, executive head of product solutions at Old Mutual Corporate, tells BizNews the reason often comes down to nothing more than timing, whether someone retires, is retrenched, or simply starts drawing an income at the wrong point in the market cycle. Van der Vyfer makes the case for a better outcome than the industry's usual fix of dialling down risk as retirement nears, arguing instead for rethinking how the investment journey itself is designed. That thinking includes a newer model called Collective Defined Contribution, which Old Mutual is set to roll out its own version of in the coming weeks. It is based on sharing risk across a group of members rather than each person carrying it alone, Van der Vyfer also explains what this means if you're already retired and living with the risk of simply outliving your money. – Linda van Tilburg

Edited transcript of the interview

Linda van Tilburg (00:00)

Imagine two South Africans who did everything right for the day they retire. Same discipline, same contributions, same decent long-term returns. Yet one retires comfortably and the other doesn't. It sounds unfair, but it happens. I'm joined today by Fred van der Vyfer, executive head of product solutions at Old Mutual Corporate, to find out why this happens, why there are such different outcomes, and what can be done about it. Hi Fred, so nice to see you today.

Can you explain the scenario for us about one person ending up retiring comfortably and the other one that doesn't?

Fred van der Vyfer (00:31)

The difference between two individuals who have done everything the same can sometimes be as simple as 30 days. If you think back to when you started your career, you probably finished your studies at the end of a calendar year, with your final exams in November of that year. And thinking back, many of us had a decision to make: do we want to start on the 1st of January or the 1st of February? And many people thought, let me just take a break after my studies, let me start on the 1st of February.

Let's fast forward. Two individuals starting their working careers one month apart, meaning they retire after 45 years of saving for retirement, or 40 years of saving for retirement, also one month apart. Now let's say that one month was the difference between March 2020 and April 2020, just after markets had fallen by 25%.

And what we have found is that in the current retirement system, where there are defined contributions, a lot of the risk attached to saving for retirement, investment risk, has transferred onto individual members. And that means there are a number of disciplines each member needs to follow to secure the best possible retirement outcome. Contribution rates, keeping fees down, having the right investment strategy and exposure to growth assets.

But even if two members do exactly the same thing, if they just happened to start working one month apart, and therefore retire one month apart, that could mean a 25% different outcome for the rest of your life, if you happen to do it at the wrong time. And so, our studies have shown, in the work that we've recently done, that we can identify which levers are within your control and which are outside of your control.

And we found that the timing of when you retire is out of your control. And that can be one of the biggest drivers of retirement outcomes, which I'm keen to dig into in a bit more detail with you.

Linda van Tilburg (02:28)

Well, the conventional wisdom or advice is save more, preserve your savings, stay invested. So, is that not enough anymore?

Fred van der Vyfer (02:58)

It's the basics. You really still need to do all of that. There's no way you would be able to secure a good retirement outcome if you don't save enough diligently per month. There's no way you will secure a good outcome if you don't save for long enough. So, at Old Mutual, we like to think about it as a number of levers you can pull to secure a better outcome. And some of the most basic and important levers are those disciplines of an individual.

What we have found, though, is that even if you do all those things right, there is still the elephant in the room, if I can put it that way. And that is that the exact timing of when you withdraw from that fund can play a massive role, because you are invested in markets that go up and down. If markets moved in a straight line, then it would simply come down to those earlier disciplines you referred to. But because markets move up and down,

there's a residual factor that determines your outcome that is often outside of your control, and that is literally the timing of when you start, the timing of each investment into the fund, but most importantly the timing of withdrawing from that fund.

Linda van Tilburg (04:14)

So how do people actually protect themselves against that?

Fred van der Vyfer (04:44.962)

That's the million-dollar question. And the sad reality is many people in South Africa are not really protected against that. Let me unpack why. The conventional wisdom tells us that over the long term, we need to take investment risk. There's no way that if you keep the money under the mattress, or more conventionally speaking, if you just save in safe asset classes,

like a money market fund, that fund over a 40-year period is going to deliver returns slightly above inflation, and then after fees you basically just keep up with inflation. Now some people say, well, what's wrong with that? The reality is, if you have 40 years of a working career to save for almost another 40 years of life thereafter, yes, that implies you're going to live to 100, and these days that becomes possible.

If you think about it, you then need to save half your salary. So, if you save for 40 years to live off that for another 40 years, but your investment returns just keep up with inflation, you need to save half your salary. And that is unaffordable for most South Africans. So, what you need to do is earn investment returns over those first 40 years that are significantly above inflation, say 5%

more than whatever the inflation rate is over that period. The only way to do that is to take investment risk, to invest in equities and other risk-carrying asset classes. And so, this is where I'm coming to your question. Most people, if they take the appropriate amount of investment risk, have no way of avoiding exposure to those investment markets being significantly down at the precise point in time when they retire.

And this is the reality. We find that most conventional retirement strategies in South Africa expose people to that risk. And in the current world, the only way of avoiding it is to not invest in those growth assets, and therefore almost lock in a lower return, which by definition locks in a suboptimal outcome.

Linda van Tilburg (06:40)

So, can you smooth out your investment journey so that this doesn't happen?

Fred van der Vyfer (07:11.19)

Smoothing is a very loaded word, and what I like to rather think about is, can you share that risk with your fellow investor? It's a bit of a philosophical question, and I like to answer it by thinking about other areas in my life where I'm exposed to financial risk. 

The first one being my health, medical aid. I think most of us are fortunate to participate in some form of medical aid. If you think about it, that is risk sharing. In any given year, my contributions to medical aid will definitely be different to my actual healthcare cost in that year. But what I've done is share this risk with all the other members in the medical aid fund. Same goes for car insurance. 

You don't know whether you're going to crash your car or not, but you share that risk with all the other policyholders, and therefore you secure a better outcome without having to take on the risk of driving out of your garage yourself. And it's that very same philosophy that says, yes, it ends up practically meaning you smooth out the investment returns, but behind the concept of smoothing returns is effectively sharing the risk of retiring at the worst possible time with a group of other people on the same journey, who will retire at different times. So, the cost when markets are down is then subsidised by those who exit when markets are up. That is what we call smoothing of investment returns, but there's actually a powerful philosophy behind it.

Linda van Tilburg (08:39)

You and Warren Matthysen have been working on something called Collective Defined Contribution. So, what is that?

Fred van der Vyfer (09:07.54)

This is really, really interesting. It's the new buzzword in retirement savings. In South Africa, similar to the rest of the world, we're all very familiar with the two main retirement systems: defined benefit, often referred to as DB, and the more modern version, defined contribution. In the old days, in a defined benefit fund, if you worked for a company for 40 years, that company effectively paid your pension for the rest of your life. In a way, your pension was secure. You didn't carry any risk as an individual; the company carried all the risk. And for various good reasons, the whole system transitioned to a defined contribution system, effectively a savings scheme, where you have defined contributions into the fund.

 Those contributions are then invested in the market, as we discussed earlier, and therefore the outcome can be volatile and all over the place depending on when you retire. That has been a problem global pension systems around the world have been grappling with, and the predominant wisdom and trend these days is to find some middle ground between the old defined benefit system and the current defined contribution system. 

Effectively what that means is you still have a system where you have a fixed defined contribution, a percentage of your salary that you save. So, we're not going back to a world where a company, in a very paternalistic way, needs to pay the pensions of all their ex-employees for the rest of their lives. But what we do borrow from the old defined benefit system is this philosophy of risk sharing.

So, a collective defined contribution system, in a way, is the best of both worlds. You have a savings scheme, but the investment risk within that savings scheme is shared amongst all the members. That does two things, if I may elaborate. It gives you a very effective risk management tool in your arsenal. 

Sharing that risk is a mechanism to manage the risk, and in a way, it allows you to take more risk. This sounds counterintuitive, but the studies show that if you have an effective way of managing that risk, it means you can take more risk in the underlying investments. 

All things equal, you can invest less in cash and even more in equities and risk-carrying asset classes that deliver higher returns over the long term, which then lifts the outcome for the whole population of savers. And that really is the fascinating, counterintuitive result of what's happening: finding risk sharing as an effective tool actually allows you to take more risk and lift outcomes across the group.

Linda van Tilburg (11:44)

And what are the limitations of it?

Fred van der Vyfer (11:56)

There are, there will always be, there's no silver bullet. The first limitation is that sharing the risk doesn't mean there is no risk remaining. If the whole market goes south and stays in a depressed, prolonged period, like the Japanese equity market or the Russian market for example, smoothing out that very poor investment return outcome is still not going to save you from that.

So, there's risk sharing, but not ultimate guarantees. And therefore, one of the biggest challenges internationally is to manage the expectation that even though your outcomes are a lot more predictable, they are still not guaranteed. The only way to really find a guarantee is either to go back to your employer and ask them to guarantee your pension, which is not going to happen, or to outright buy a guarantee from an insurance company, which is still possible. But a CDC in and of itself doesn't provide guarantees, it just manages the risk by sharing it. And that is one of the remaining challenges of the system.

Linda van Tilburg (13:08)

Has Old Mutual done research to see how this could actually help people?

Fred van der Vyfer (13:38.763)

Indeed, we have. At our Old Mutual Thought Leadership Forum, which started in 2024, at the very first one we invited international speakers to come and talk to us about collective defined contribution systems and how they are implementing it in the UK. And in the two years since then, we've done a lot of internal studies to see what a collective defined contribution system could potentially look like in South Africa, recognising that the very same risk sharing, or smoothing of investment return principles that is applied internationally, we already apply to a large extent in our smoothing-only investment products in South Africa.

If you then add to that the post-retirement piece, where you also share longevity risk, which is the risk of people living longer than average, we find that we don't really need a third category of pension system introduced into law, in the same way as in the UK. We can, within the environment we currently have, already apply these risk-sharing principles. 

And at our Thought Leadership Forum, about a month from now, in October, Old Mutual will be launching our version of the first practical implementation of a collective defined contribution proposal and proposition in South Africa, which is something we're really, really excited about.

Linda van Tilburg (14:44)

So how should the industry respond to the fact that there are different outcomes for people who have made the same contributions?

Fred van der Vyfer (14:54)

I think as an industry, we should recognise that it's not as if the industry hasn't grappled with this issue and tried to respond to it. The most predominant strategy to deal with that risk of volatile outcomes has been what we refer to as life-stage investment strategies in South Africa. 

Effectively, what that means is, as you get closer to retirement, the investment strategy dials down the risk. It invests more and more into conservative asset classes and less into equities in the 10 years leading up to your retirement. Now that is not a bad strategy in and of itself. Most predominant umbrella funds, investment funds and retirement funds use that strategy. But the problem that remains is that you lose out on that exposure to growth assets in the last 10 years before you retire, which is often the 10 years when you need that growth the most, because that's when you're sitting on the most assets. 

And then, adding to that, post-retirement you have another 20 to 30 years of time horizon to remain invested. But now you're out of the growth assets, so you no longer get that growth post-retirement either. So, the industry has responded to this risk of volatility and variable outcomes effectively by dialling down the risk and reducing the expected outcomes for the whole population.

 We think there's a better way, and that better way is to use risk sharing as the mechanism to manage that volatility of outcomes, that uncertainty of outcomes, and keep your exposure to growth assets throughout life for longer. And that really is the fundamental argument behind Collective Defined Contributions, why it's gaining so much momentum internationally, and why we at Old Mutual are also really interested in looking into it.

Linda van Tilburg (16:58)

So, what would you want to say to somebody watching this now, who's maybe 10 or 15 years from retirement, or younger, just starting out? What difference should they make after hearing this?

Fred van der Vyfer (17:13))

The important thing is for an individual to first remain committed to the levers within your control. This is not a silver bullet that will in and of itself help you reach a better outcome by contributing less. So, all the very basic factors that drive a better outcome are still there. What we hope this will do, and what we hope people listening will appreciate, is that there is a lot more certainty possible in your outcome by sharing that risk, and that having the option to share the risk you're taking as an individual with other members in your fund, as a potential default strategy, should allow people to have more confidence in their outcomes. 

Ultimately, what we hope for is that people don't see their contribution into a retirement fund at the age of 25 or 30 as just some money the government is almost forcing them to save into some black box somewhere, hoping for the best one day. We really hope for a scenario in which people have much higher confidence in the future outcome they can expect and therefore engage with their retirement savings in the same way they engage with other investments and assets.

So, it really is a positive message we want people to hear that there is a better way to deliver more predictable outcomes, while still taking the risk necessary to earn returns over the long term.

Linda van Tilburg (18:59)

So, this is all about people before retirement. What about people after retirement, or who have already retired? Do you have any message for them?

Fred van der Vyfer (21:36.975)

Exactly. What we've actually been focusing on is the hard work you need to put in until you retire. But the ultimate purpose of retirement savings is to deliver an outcome post-retirement. And the strongest arguments and benefits of a collective defined contribution are actually in the delivery of income security, or a higher degree of income security, post-retirement.

What we mean by that is recognising that in the current system, most South Africans who retire out of a DC fund, a defined contribution fund, end up in a living annuity. Now, there are many benefits to a living annuity, but one of the biggest drawbacks, or risks, is the risk of running out of money if you live longer than average, or longer than the models predict people to live on average. 

That is what we call longevity risk, the risk of living longer than expected and therefore running out of money. And within a collective defined contribution fund, that risk is also shared amongst a group of individuals, meaning that if you live longer than expected, the collective group continues to fund your pension. And that is one of the most powerful drivers of more consistent outcomes in retirement that we are seeing.