Is your retirement fund failing you?
The one-size-fits-all approach may ignore crucial differences
Your retirement fund may be failing you because its one-size-fits-all saving formula doesn't cater for your unique financial situation.
South Africa's largest retirement fund administrator believes it can fix that by introducing an investment strategy personalised for each member.
Alexander Forbes-administered retirement funds will from next month be able to implement Clarity, an investment framework that allows you, as a member, to set your own retirement income goal, with a unique investment portfolio aimed at optimising your chances of achieving that goal.
The model moves beyond the life-stage model used by many retirement funds in terms of which your retirement savings are invested in line with the number of years you still have until retirement.
The life-stage model reduces your exposure to more volatile investments designed to deliver growth - equities and listed property - in the last five to 10 years of your working life to reduce the possibility of you losing money if the market falls when you no longer have time to recover from losses.
Most retirement funds target a pot of savings that is intended to provide you with a pension that represents a percentage of your income (your net replacement ratio) in your final working years.
To reach the target, you (and your employer if it is contributing on your behalf) need to contribute a certain percentage of your income for a set number of years, earn a certain level of returns and not spend any of your savings along the way.
Most funds target a certain percentage of salary in retirement
Failing to adhere to these requirements will likely result in your savings realising a pension below the target.
To rectify this you will need to save more, work beyond your planned retirement date or invest more in growth investments such as equities, but you may not realise this when your savings are invested in line with a life-stage default investment strategy.
Sanlam's Benchmark retirement fund survey suggests that the default investment strategy of more than 60% of retirement funds is based on the investor's life stage.
You may also end up with too little exposure to growth investments that you need to fund your income in retirement.
Most members use investment-linked living annuities to provide an income and may need to plan for these to sustain an income for as much as three decades.
In addition, the cost of buying the income you need changes over time as the cost of the asset classes in financial markets changes.
This means that even if you contribute enough and preserve your savings throughout your working life, you could still end up with an income below that which your fund has been targeting for you.
Alexander Forbes's personalised investment strategy draws on the work of Massachusetts Institute of Technology professor and Nobel laureate Robert Merton, who has been working with local investment manager Colourfield.
Shaun Levitan, an executive director and co-founder of Colourfield, says two people of the same age may need to invest their retirement savings in different ways because of:
- Their gender - women typically live longer than men;
- Their savings to date;
- Their returns to date;
- Whether they preserved their retirement savings in the past; and
- Their income goals in retirement.
Despite being the same age and earning the same salary, one member may be on track to have a pension that is equal to 45% of their income and the other may already have saved enough to provide 100% of that income as a pension.
Assuming they have the same retirement income goal, they should not have the same savings strategy, Levitan says.
The one needs a high allocation to growth investments and the most prudent thing the other can do is to consider investing in a way that matches their future income needs more closely, he says.
Most funds target a certain percentage of salary in retirement, but the investment strategy fails to take into account whether or not you are on track to achieve that target.
John Anderson, head of client solutions at Alexander Forbes, says the company will offer allocations matched to income needs as the default investment strategy on all funds under its administration from April 1. Anderson says if you are a member of one of its funds it will design your investment portfolio taking into account all the information the administrator has about you including your income goal, age, gender and the savings you have in the administrator's preservation fund, umbrella fund or RA, but not savings held with other financial institutions.
Anderson says the investment management cost for members with varying levels of exposure to growth assets will be in line with what the group's investment company is currently charging because members' funds will be invested in a blend of actively managed and passively managed smart beta funds (funds that invest in line with rules
designed to harvest investment factors that drive the market).
Only funds that choose the peer-focused portfolio of active managers to manage their growth assets may pay a higher fee.
David Gluckman, head of special projects at Sanlam Employee Benefits, says Sanlam considered adopting Merton's methodology, but was not convinced the additional cost would be beneficial for most members.
Gluckman says if you want an investment strategy within your fund that is aligned to your individual needs, you will need to engage a financial adviser and give them all your personal details, including when you plan to retire, your marital status, if you are still supporting children and paying off debt.
Using this information to customise your investments will be overly complicated for many members, he says.
Sanlam uses a smoothed bonus portfolio, which smooths the volatility of returns, as a default investment for members approaching retirement, he says.
Katherine Barker, the head of Momentum FundsAtWork, says it is important for funds to offer the flexibility you need to ensure your savings can be tailored around your needs, because the "average member" doesn't exist.
She says that as a member you should be able to pull levers that will improve the income replacement ratio that you achieve at retirement.
Barker says Momentum uses an enhanced life-stage portfolio as its default. This strategy starts reducing members' exposure to growth assets from seven years before retirement.
If your retirement fund keeps reporting how big your pot of savings is, you are probably focusing on the wrong number. As a member of a defined contribution fund you only receive your own and your employer's contributions to the fund plus any growth on those contributions at retirement.
Fund statements typically record these contributions and the growth on them as your fund credit or the lump sum you have accumulated so far.
But a lump sum, like R1-million, can seem like a lot of money until you work out that it means a pension of around only R3500 a month at retirement. It is this number you should focus on, says Shaun Levitan, the executive director of Colourfield.
He says your fund should also tell you how future contributions will change your likely pension.
Many retirement funds report the projected replacement ratio - the percentage of your current income you are likely to receive as a pension at retirement.
But you have to be sure you know what is included in that income - it may be a percentage of your pensionable salary only and may exclude items like bonuses.
Alexander Forbes plans to communicate the likely outcome of either its new default investment strategy or your chosen investment strategy as a more meaningful projected pension in rands (in today's money), with no confusion about what proportion of your salary you will receive.
Levitan says these members can then also be told what impact increasing their contributions and changing their investment strategy will have on that income.
A number of administrators including Momentum and Sanlam offer members interactive online or app tools to test the consequences of increasing or decreasing contributions or withdrawing your savings when changing jobs.