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It’s not enough to save hard to create a retirement income; astute decisions need to be made – regularly – about how your assets are allocated and where they are invested. This is underscored by Dawn Ridler, founder of Kerenga Wealth Ecology, in this in-depth piece on how to develop your financial plans so that you have enough to cater for a comfortable lifestyle until you draw your last breath. Ridler is one of the most popular guests at our regular BizNews Finance Friday webinars for the BizNews community – with good reason. She draws on her in-depth knowledge of markets, tax, and investments and synthesises this with her expertise in ecology to explain, in layperson’s terms, the nuances of the complex world of managing money with a view to helping us all empower ourselves. Dawn is back as a guest panellist at this week’s BizNews Finance Friday webinar. Free to attend. Scroll to the end of the article for registration details or click here to sign up. – Jackie Cameron
Retirement income: Harvesting your lifelong saving efforts
By Dawn Ridler*
The whole point of saving for retirement is that there comes a time where you can stop relying on active income (a job) and allow the passive income (retirement savings) to take their place. Having spent your whole life building your farm/investment, getting up early, working your fingers to the bone, and reinvesting your proceeds, you can now get a farm/asset manager to look after the farm, and just pay you a passive income.
For that farm to sustain your income needs indefinitely, there are a couple of no-brainers. You cannot ignore the farm, plant nothing, pick nothing, and just sell off bits of land when you need money. Eventually you’ll have no farm left. In investment terms, this is what happens when you eat into your capital to fund your retirement. You’ll be surprised how many people use just this ‘strategy’ in retirement.
So, how can you make your retirement income sustainable?
Firstly, you have to decide where you are going to get your harvest from, then look after it, reinvest in it, and live within your means during your working years. Diversifying the crops on your farm is a good idea, just like having different sources of ‘retirement’ income. Some of it can come from formal retirement products, but there should also be other sources, whether other investments or rental portfolios, side gigs, etc. You can, of course, decide never to retire but to have an active income well past the normal retirement age. Some people choose to do this, others have to because they cannot afford to retire. P.S. If you don’t want someone telling you when your retirement date is, work for yourself (my major motivation for getting out of the corporate environment 13 years ago).
Secondly, diversify. Just like a farm, there are hundreds of different crops that you can plant, each needing different conditions, harvesting at different times – sometimes months (veg), sometimes years (orchards), others decades (pine trees, for example). Monoculture is the (unhealthy) practice of planting just one crop, year after year on the same ground. This is risky – you increase the chance of losing your entire crop to the weather, disease, or even theft. You also deplete the soil of essential nutrients that can take decades to recover. (Avocado farmers in South Africa now have to guard their crop at harvest to stop thieves coming in at night and filching the entire crop). Investment diversification means using different asset classes – not just cash, bonds, stocks, and property but commodities, ETFs, and global investments too.
Thirdly, understand what your ‘passive income’ needs are going to need (in present value terms, let your planner worry about returns and inflation). Draw up your ‘now’ and ‘then’ income statement (aka budget). If you haven’t yet retired, it will still be possible to adjust your consumption and your investments to match this ‘income need’. When you’re at retirement you have fewer options – because you aren’t going to be adding to the pension pot anymore. If the pot isn’t big enough, your only option is going to be to consume less. That is not a happy discussion to have with a new retiree or your spendthrift spouse.
Structuring a sustainable (and more certain) income: I often tell my clients that I would rather incur their wrath and recommend a lower income than have to face them in 10/15/20 years’ time and tell them the money is running out. Obviously over the last year many people’s income and retirement has been pushed out of whack, and temporary adjustments have to be made, but if a client’s expectations way outstrip the reality it makes a planner’s job impossible. A sustainable income means that the income (increasing with inflation) will last them the whole of their life, even if they become a centenarian. To achieve this you cannot just withdraw an income (the ‘drawdown’) you have to put some back (reinvest) so that it can keep up with inflation.
In RSA you can design a retirement portfolio with a ‘drawdown’ (your income/pension) of 4.5% of the capital and be sustainable, certain, and grow with inflation. We’re lucky – in the west you’re lucky to be able to take a 1.5% drawdown to get the same effect. This has put offshore pensioners in the unenviable position of having to take on much more risk on the stock exchange to try and boost their returns and increase their drawdown.
When the 12-year US bull run corrects, pensioners are going to lose capital. Say you live here in RSA and decide to retire overseas, that pension pot you take overseas with you is only going to produce 1/2 to 1/3 of the income you might have enjoyed in RSA (never mind the higher cost of living) – or you’ll have to start using capital. Get advice from a Planner before you decide to retire in Provence (don’t get me started on Estate duty and Wealth Tax).
Ways to slice & dice your pension savings for a certain retirement income
There is more than one way to structure your pension pot to give you a sustainable and certain income (without resorting to a ‘life annuity’ that dies when you do).
- You can hive off and liquidate a portion of the capital to use for a year or two, and let the ‘farm’ keep growing, and then repeat the process when you run out. This is a popular method, especially for retirees who DIY their retirement funds. This assumes that the farm/investment will keep on growing nicely and more than make up from the bit you took out – but that has a much higher risk than money in the bank. On a farm, fires, drought, and disease can wipe out some or even all of that capital – in investment terms this is the equivalent of liquidating some stocks (capital) every year to live on, leaving the rest to grow in the stock market and hope there isn’t a crash at a crucial time.
- Many unit trust-based retirement funds (annuities) will use a similar method to the one above. Once a year the provider will hive off a chunk of the unit trust and put it into money market to pay you the income. If the unit trusts have been chosen to specifically produce the income sustainably without unnecessary risk, that method is fine. You might have no option but to use unit trusts because of the size of the investment, but it can still be invested sustainably, in low-cost ‘balanced’ unit trusts. Remember that in retirement there is no room for mistakes so make sure you or your planner keep an eye on the investment and whether or not it is sustainable.
- Another way of doing it is to ‘catch’ the yield coming out of a portfolio (interest, dividends, bond coupons, rent), putting some back to grow the portfolio and living off the rest. This is especially important if the retirement portfolio is diversified with annuities, flexible funds, etc. It does take more management, and may require consolidation over time but is my preferred method of retirement income management for a number of reasons:
- No selling of capital needed. This can trigger Capital Gains tax in flexible (non-formal) pension investments and you aren’t hamstrung into hoping that the ‘time is right’ to sell the capital.
- If you design a retirement portfolio to build in the sustainability and certainty (low risk) you often have an excess to that ‘Income Producing Block’ that can be invested for a legacy, and be much ‘risker’ and be fully offshore, all stocks, etc. without impacting on the retiree’s lifestyle in the future.
- The asset manager has much more flexibility in managing the portfolio – he can buy and sell specific assets/bonds/shares that are needed in the portfolio (or have passed their usefulness) without cutting off bits of the unit trust like a slice of polony. While you might feel that using a huge unit trust with billions of assets under management is safe, consider that they often end up owning large chunks of one share (especially in a smallish market like ours in RSA) so they cannot just dump a share that they know is in a pile of trouble because the act of dumping that huge volume will move the market. Do you think the big unit trust asset managers didn’t know what was happening at African Bank/Steinhoff?
Looking at yield: The days of ‘buy and hold’ to build retirement income are long gone
Farmers will know down to the last kg what sort of yield their crop will produce in good, average, or bad years. A square meter of tomatoes will produce around 10 – 40kg per annum, depending on the conditions they are grown under. Asset classes are not much different. In RSA, dividend yield is around 2%, cash at around 4.5%, and bonds and REITS higher at around 6% (in the west the yields are very different with almost no yield coming from cash or bonds). These yields change all the time, and your portfolio needs to be adjusted for them. The days of ‘buy and hold’ are long gone. Tracking just major stock markets is also unhelpful – you’re going to be better off tracking (using ETFs for example) sectors, and sectors within countries (but picking those isn’t as straightforward – active management of passive investments).
If you want certainty, then you have to reduce the risk or volatility of the portfolio.
Smell of roses: Beware of living off interest when you retire
Interest from cash (and bonds, but to a lesser extent) is like having a rose bush. You can pick roses from it at any time, but at the end of the day, all you have after years of picking roses is the one rose bush – your original capital. You could, of course, sell the roses and buy more rose bushes (reinvesting rather than consuming the yield).
Dividends from shares (and rental income) though is more like having a mango orchard. You plant them, water them, care for them, and protect them until they are big enough to give you a meaningful harvest – and the harvest gets bigger as the tree matures. (Interestingly, a mango tree will often produce fruit when very young, but if it is left on the tree, the branch will break from the weight, so we usually cut it off before it can sap energy out of the tree or break the trunk.) Once fully mature though, mango trees will produce a good harvest for years that can be picked, consumed, or turned into cash. This is like a stock. Early in your investment career, you will need to plough back the dividends/yield so that your investment orchard can grow so that when you need that yield, you can harvest and consume without impacting the capital.
Gold and commodities are like spinach – an annual crop (as are most of the veggies we eat) – you sow it and harvest the entire plant, leaving you with an empty field to start again. This is an asset class that is all capital and the growth of that capital. Gold and commodities are also a good ‘store of value’ but go through their own ‘super cycles’ and are not really a ‘buy and hold’ asset because over the long term the price is pretty flat.
Whether you do it yourself or get a planner to help you, a retirement plan is essential – there will be no time to correct mistakes later. Making your retirement income sustainable and certain is the boring, adulting thing to do – you can always be irresponsible with the excess.
- Johannesburg intermediary Dawn Ridler, MBA, BSc and CFP ® is founder of Kerenga Wealth Ecology.
Want more insights on how to manage your assets for a comfortable retirement? Sign up for the free, highly interactive BizNews Finance Friday webinar. On 23 April, Dawn Ridler and cryptocurrency expert Sean Sanders of Revix are available to answer your personal finance questions: Register here: https://attendee.
For more by Dawn Ridler on how to build a sustainable retirement income, see:
- 12 important money questions for South Africans who want to invest offshore – Dawn Ridler
- Retirement annuities revisited – Dawn Ridler
- Why smart investors chase low fees, dump greedy fund providers – Dawn Ridler
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