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Over the past two decades, there has been a series of changes to the manner within which retirees will live out their retirement years. This two-part series will begin to explore the significant demographic, regulatory and psychological changes that are likely to influence the way in which retirees enjoy their twilight years.

The main focal points will be:

• Demographic changes, specifically those affecting mortality and average retirement age;

• Regulatory changes, including the move from defined benefit to defined contribution funds, and the introduction of the Financial Advisory and Intermediary Services Act; and

• The investment psychology of investors and the potential impact on investment returns.

Over the past 20 to 25 years, South Africa has been through a significant number of changes that will dramatically affect the extent and quality of retirement years enjoyed by retirees.

In order to understand these, it is appropriate to consider the profound impact that the length of the investment term and the investment returns will have on the investor.

Before reviewing the underlying tables, answer the following simple questions:

Would you prefer to:

A: contribute an equal monthly amount of R1 000 from the date of your first pay cheque when you started work at 25, but stop contributing when you are 35; or

B: start contributing R1 000 per month at 35, but stop contributing when you are 65?

In order to understand the impact of compounding over time, consider the profound disparity between A and B in the table on the next page.

A starts contributing at 25, but stops 10 years later. B only contributes from age 35 onward. I have assumed a return of 10% per annum (this is an important number, the basis for which I will explain later).

When both A and B retire at 65 years, A has a staggering 168% more investment capital available than B – does it sound too good to be true? That is the benefit of compounding over a long period of time, and the wisdom of investing from an early age.

However, think back to your first pay cheque and consider your desires at that time: retirement only happens to other people and the new flat, car or holiday are much more pressing issues.

The table below attempts graphically to alert you to the very real benefits to long-term investing.

There are two major drivers of the final returns: the length of time and the annual appreciation.

When looking at the expected returns, I have assumed that South Africa is likely to continue to target consumer price index between 3% and 6%; and I have assumed that investors will target a real return of around 4% to 5% – making an average expected return somewhere around 10% realistic.

If one now starts to consider the demographic changes I alluded to earlier, the investment outlook starts to look like Beijing in the morning – decidedly gloomy.

The first statistic is as follows: Over the past 20 years, the average retirement age has declined from 65 years to only 57.
(Source: Cadiz)

This is a significant trend and can probably be attributed to South Africa’s changing political dispensation coupled with the international trend for employees to move jobs more frequently.

Another significant impact has been extended life expectancy due to modern medicine and healthcare, which has seen expected mortality rise from 75 to 85 – fully 10 years. (Source: Cadiz)

Both these factors will have a dramatic impact on the funds available for the average pensioner once in retirement. Again, I have provided a table (overleaf) that graphically depicts the impact on the ultimate cash available to the retiree.

I have assumed in all cases that the retiree has contributed from 25 years, and in the various scenarios have changed only one variable at a time (retiring at 57 years, and then living to 85 years).

This table mainly focuses on the annuity available to the investor during his/her retirement years.

Twenty years ago, the investor would have enjoyed an annuity of R79 386 for his/her 10 years of retirement, starting in the 65th year end, ending at expected mortality 10 years after at 75 years.

Consider the dramatic impact of retirement at 57 years (some eight years earlier), which slashes this annuity to only R27 099, about one-third of the comparative.

Finally, add to that the impact of living a further 10 years, and this drops even further to R23 881 – or only 30% of the comparative.

From the aforementioned examples, there is an object lesson to be learnt:

1. Investment for your retirement is fundamentally about investing for the long term. The longer you invest, the larger the final expected value will be.

2. Retiring early is something that will need to be planned for. This will typically involve investing significantly more during your working years; and

3. Living longer is a wonderful proposition but, again, the lifestyle will be dramatically impacted by the funds you have available to retire on. Again, it will be critically important to begin planning for a longer retirement age before retirement.

In part two of this series, I shall explore some other factors that are having a dramatic impact on the retirement funds available to retirees. These will include the collateral damage on investment returns because of investor bias, and the heightened risks that financial advisers perceive due to recent advisory legislation.

Evan Jones

Managing director: Cadiz Wealth

Director: Cadiz African Harvest Asset Management

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