It is well known that as things stand, the majority of South Africans will not have enough money to sustain their current standard of living in retirement.
Recent increases to value-added tax and the fuel levy, among other things, have worsened the outlook for many.
Retirement savers would do well to avoid fairly common investment mistakes, according to chief executive officer at 10X Investments, Steven Nathan.
Here are the 10 mistakes retirement savers frequently make, and how to avoid them:
Mistake #1: Saving too little
The number one reason most people miss their retirement goal is because they don’t save enough.
“No rocket science here,” says Nathan. “You can’t save like a pauper and then expect to live like a prince in retirement.”
The basics of a successful model for retirement is that people should save 15% of their gross salary throughout their working life (an average of 40 years) and invest in a balanced high equity fund that charges low fees.
Mistake #2: Paying high fees
Fees matter a lot more than most people imagine, says Nathan. In the context of a 6.5% real return (that is after inflation), every 1% paid in fees reduces the return by more than 15%.
If investors are paying 3% in fees the return will be reduced by 45%, which means that more than half of the real annual return is lost to fees.
When the effect of compounding, where you earn a return on your return, is included the negative impact can be devastating.
Nathan urges investors to understand the fees they are paying, and to look for a low-cost provider that charges no more than 1% in total annual fees.
Mistake #3: The wrong asset mix
Choosing an asset mix that mirrors personal risk tolerance, such as conservative or risk averse, but is not appropriate for the investment time horizon can dramatically damage a retirement outcome.
"It is critical to grow your savings at a high rate for the majority of your savings period, which is why you should be invested in a high equity fund," said Nathan.
"A lower growth portfolio would be insufficient in the context of a 40-year savings plan, based on a 15% savings rate."
A life-stage solution, where one can automatically be switched to the appropriate portfolio as the time horizon changes, is a simple and effective solution.
Mistake #4: Investing in an underperforming fund
Nathan said that, when it comes to retirement investing, it is more important to eliminate the downside risk and reach the minimum savings goal than to entertain upside risk in the hope of overshooting the savings goal.
"No one should be gambling with something as important as their retirement savings," says Nathan.
Mistake #5: Emotional switching
Chopping and changing funds or asset classes, especially during periods of market turbulence, often leads to buying high and selling low.
Investors should rather stick to their plan and avoid the temptation to switch or try to time the market.
Mistake #6: Inadequate diversification
If you are over-invested in one asset class or security, you assume concentration risk, the risk that one investment will have a disproportionate impact on your savings outcome. As a retirement investor, you cannot afford the downside risk as it may ruin your pension.
Nathan says: “Remember, it’s about reaching your goal with the lowest possible risk; it is not about speculating your way to a dream existence.”
Savers should invest in various asset classes (equities, bonds, property and cash), each providing exposure to many different underlying securities, held across different currencies (local and international) and regions (for example, developed and emerging countries).
Mistake #7: Saving outside retirement funds
Tax-free deductions and investment returns can potentially increase the value of your retirement savings by up to 30%.
And you score again because your retirement income is almost always taxed at a lower average rate than the marginal tax you saved on your contributions.
Mistake #8: Starting to save too late
Few people in their 20s worry about retirement but, ideally, we should start saving towards retirement from our first pay cheque. We should keep it up throughout our working life (around 40 years on average).
Nathan says it is important to remember that contributions are only one source of your future retirement income. The other is the net investment return you earn on your contributions.
“The sooner you start contributing to your retirement fund, the longer your money has to grow.”
Initially, Nathan adds, the returns add only a little to your total pot, but once compounding (earning a return on your return) kicks in, the growth will pick up and continue building momentum.
“The effect is much like a snowball rolling down a mountain, until the compounded investment return totally overwhelms your contributions.”
Mistake #9: Cashing in savings on changing jobs
Not preserving what has already been saved is a very common mistake in South Africa: up to 80% of fund members have at some point cashed out their savings when they changed jobs.
Not preserving is like starting late: people lose not just the accumulated savings, but the return on those savings for the remainder of the savings term.
The foregone return becomes a big number when a fund is cashed in 30 years ahead of time.
Mistake #10: Underestimating how much money is required
Using a quality retirement calculator (based on accurate inputs and assumptions) provides a good sense of where savers stand relative to their goal, and what they could do to improve their savings outcome.
“When it comes to retirement planning, various factors are beyond your control, such as the macroeconomic environment and stock market performance, which makes it even more important to understand and control the many factors that you can,” says Nathan.
Steven Nathan is the chief executive officer at 10X Investments.
