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[TOP STORY] Protecting your capital growth during retirement

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SIMON BROWN: I’m chatting with Pieter Hugo, chief client and distribution officer at M&G Investments. Pieter, I appreciate the time today. One of the common perceptions around retirement is that when you are a couple of years out from retirement you start de-risking your portfolio. You move into cash, move into bonds. By the time you hit retirement your portfolio’s relatively low risk.

You’re saying, ‘hang on a second, you actually make a bunch of that return in retirement’.

PIETER HUGO: Hi, Simon. Yes, and thanks for allowing me to talk to you. That’s absolutely true. We often see when clients get to retirement or even before retirement – because we work in a defined-contribution scheme now, which effectively means that everyone has their own little pot of money that they are saving for retirement – this is typically the only pot they have for retirement, to last them for their entire lifetime.

Clearly you feel you do not want to lose that money. The logical next step is that clients typically tell their advisors, ‘Please de-risk me or invest conservatively because I don’t want to see this money going down, and I don’t want to see it being volatile’ – which is just a fancy word for the money going up and down every time you look at your statement.

But the problem with that is that, while it makes you sleep or feel very comfortable in the very short term, because your money grows very smoothly, you typically give up a lot of growth in retirement. What you don’t see is that, by design, you are likely to run out of capital a number of years earlier by giving up potential growth in retirement.

SIMON BROWN: The point is there are a couple of moving parts here. One is at your retirement age you’ve truthfully got the largest amount of money you’ve ever had. You’ve also probably got, depending on the numbers, perhaps 30, 40 years of living to go. And, to your point we are worried about the money depleting, instead of actually saying, if I tell a 30-year-old that they must de-risk their portfolio, they will think I was crazy. We need to de-risk a small part of the portfolio.

PIETER HUGO: Yes, absolutely, Simon. As you say, there are a number of moving parts here that you need to think about. Firstly, people typically retire earlier these days. It’s 60, typically not 65-plus, [and] we all know people are living longer. So your money needs to last you. If you retired at age 60, there is a very high probability that you may make it to 80 or 90. That’s 30 years in retirement, especially if you look at joint survivorship – in other words, a husband-and-wife type of couple.

If you look at the last surviving one of them, there’s a very, very high probability that that one will survive for at least 40 years. And now you think if you want to invest for 40 years, if you are going to have a certain [amount] in cash for 40 years, you’re probably going to earn a 1% real return in cash over those 40 years.

But now if you look at living annuities across the industry, an average drawdown rate is in excess of 7%. So if you want to draw down in excess of 7%, but you sit with a big chunk of your money in an asset class that delivers you only 1% real, you are going backwards in real terms, if not in nominal terms as well. That is the big challenge – that one needs to get that trade off right between giving yourself a smooth type of ride, but also having sufficient access to growth for your long-term money. And, as we say, this is a long-term investment.

SIMON BROWN: It absolutely is. It doesn’t end as you retire. In the research that you guys have done says that some 87% of total investment value is generated in post retirement. That is, again, because of longevity and because of the amount of money. When I’m a 30-year-old, I don’t have much money saved for retirement. When I’m 60 I’ve got the maximum.

PIETER HUGO: Yes, exactly. If you think about, it as you mentioned earlier, when you retire one day, that’s probably the biggest pot of money that you’ve had in your life – hopefully that’s the case. For most retirees that is [so]. And in fact that pot actually grows much bigger into retirement. So, if you think logically, if you receive investment returns on top of a large pot of money, that’s where you get your real return. So if [in] your pot at age 25 you only have R5 000 saved, and you earn a 30% return, it’s a high return but it’s applied to a very small pot of money.

So, as you say, your pot of money into retirement is very big, and if you give up on growth there and say I’m only going to earn 1% real on this big pot of money, but you’re going to draw significantly more than 1%, that is effectively a recipe for disaster, and by design you’re setting yourself up for failure.

SIMON BROWN: The research [says that] with 87% return post retirement, that’s sort of a 5% real return. And that then implies equities – and that does mean some volatility. So fund managers and sort of their advisors almost need to talk people through [the fact that] it’s going to be bouncy, but it’s going to last longer.

PIETER HUGO: Yes. That’s exactly the challenge. So a 5% real return. Your typical balanced fund today in South Africa probably has delivered at least 5% real returns over the last 20 years. So we are talking about that fund which has about in excess of 60% [in] equities, both SA and offshore – and that is a bumpy ride. I’m not taking anything away from the fact that it will be bumpy – and then I think that is where the value of advice comes in.

It’s difficult to see that your money was R100 000 last week and this week it’s R90 000. That is extremely painful for most people, and that is where you need someone [with whom] you can test your ideas and [that] ‘I want to get out of the market at R90 000 and go to cash’. You need someone to tell you that is not the right thing to do at this stage. You are in the right investment portfolio, you’ve done your homework up front. Stay there, it will recover.

SIMON BROWN: If one of the options then – last question – is that in the super-good years, when portfolios [have] done way more than 5% real, perhaps you [can] take a little bit extra out that you could sort of put aside for the years when you’re not doing your 5% real, to kind of smooth it yourself, almost.

PIETER HUGO: Yes. And I think that is important – and maybe you’re referring to how you manage your retirement, the amount of money that you draw out. Don’t just blindly say, ‘I’m taking, let’s say, 6% of my retirement pot’ and, if I had a good year, ‘I’m now taking 6% of a much higher number and I’m giving myself a massive increase’. Also, the research has shown that managing your draw-down rate every year is one of the biggest tools that you can have in your retirement to ensure longevity of your pot of money.

So, as you say, if it was a very good year, don’t just take an inflationary increase on your money – not, let’s say, a 9% or 10% or a 15% increase if you were lucky enough to have had such a good year. Manage your income accordingly. And if it was a very poor year, maybe take a 0% increase. I know it’s very, very difficult to do that in retirement, but you are trying to get to that balance between taking too much and taking too little.

SIMON BROWN: Well, that’s an excellent point you make as well – that managing that drawdown is the most important part of that process. Don’t just, as you say, in a good year sort of take a lot and go on a holiday. No. Stick to the number. Be very cognisant of what you’re drawing down.

We’ll leave it there. Pieter Hugo, chief client and distribution officer at M&G Investments, I appreciate the insights.

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