ANDRE TUCK: Retiring as the party stops

These financial times are out of joint. The wealth explosion in recent years has been at odds with the economic reality on the ground. While financial markets partied on, drunk on too much liquidity and negative real interest rates, the real world grappled with the fallout from Covid containment measures: millions of people losing their livelihood, entire economic sectors being obliterated, supply and labour being constrained and debt reaching record levels.

What cursed spite for those born at the wrong time, who have to set their retirement affairs right during the hangover period that will surely follow.

They would have seen their investment accounts balloon during this phase, which fuelled a sense of complacency about their retirement prospects. But the dramatic inflation surge and the resultant urgency to ratchet up interest rates are killing the mood. And it may get worse, because recent geopolitical events — especially as they affect energy prices — point to growing inflationary pressures.

The retirement transition is precarious at the best of times. You have to make some hard decisions and probably live with the consequences for the rest of your life. You risk locking yourself into a strategy or a product that may not suit you in a few years’ time. Should you choose a guaranteed annuity, you are stuck with the one you selected. A living annuity comes with more flexibility, but also the risk that your investment and drawdown strategy may not serve you later.

Then there is timing risk, because what happens in the markets ahead of this period could still scupper your plans. Retirement is when your savings are near their peak, which means the impact of any volatility is most pronounced, in absolute terms.

To mitigate this risk, invest with your time horizon in mind. Timing risk is a bigger threat for those buying a guaranteed annuity, as their investment term is short. You need to start derisking and preserving your savings a few years ahead.

That means gradually lowering your exposure to equities, and investing more in bonds and cash. Cash should hold its nominal value while you are hedged against falling bond prices, as these translate into lower annuity prices.

Alternatively, those choosing a living annuity might want to invest conservatively for more stable returns. But this won’t provide the above-inflation growth needed to make savings last over an extended retirement.

In SA, investing in a well-diversified high equity portfolio has historically delivered superior returns over periods of five years and longer, so this strategy should make your savings last longer and/or afford you a higher drawdown. Yet a sustained spike in inflation and the necessary policy response — higher interest rates — are generally not good news for your share portfolio.

And it’s a double whammy for retirees. Higher inflation ratchets up living costs, while steadily rising interest rates may result in some years of negative investment returns, as happened in the mid-1970s.

In such an environment, you may lose your nerve and switch to a guaranteed annuity or a defensive portfolio. This would mean locking in your losses and a lower income for life. But even if you do not change your strategy, you may lock in some losses, as drawing income makes you a forced seller in a bear market.

Each year you get only one chance to change your income. If the market drops just after that, you are drawing down at a higher rate.

If your portfolio drops 20%, your 5% drawdown rate becomes 6.25%. If your portfolio does not recover and inflation ratchets to 10%, you are already at 7.5% the following year. If this persists it will considerably shorten the life span of your savings.

For high-cost investors, switching to a low-cost living annuity (charging 1% or less per year), would more than neutralise a 20% loss in their portfolio value over the long term. But, even then, you should cut back, as a slight lifestyle reduction can have a meaningful impact. If you could, say, spend R2,000 less per month you will be saving R24,000 a year. And if you are drawing down at 5%, that effectively replaces capital of R480,000.

The past few years may have inflated investors’ sense of their wealth and market returns, both of which may prove unsustainable.

People in or approaching retirement should perhaps revisit their lifestyle expectations and moderate their spending plans on the assumption that their portfolio, even if it is well diversified, may give back some of the gains of the past three years.

Yes, recent developments are already priced in, but each could take a turn for the worse. Rather get a pleasant surprise if it doesn’t happen than a nasty shock if it does.

*Tuck is a senior investment consultant at 10X Investments