PUTTING AWAY THE CORRECT AMOUNT TO BE ABLE TO RETIRE COMFORTABLY
Over the years of writing articles and Financial Views we often revert back to one of our favourite topics – the power of compound interest. The reason we do so is because this is the core fundamental concept in building wealth, getting your money to “work for you” by “working for itself”. On review of our client portfolios, we have seen how compounding has worked but to ensure that our clients achieve a successful retirement outcome we also focus on the amount that they invest. In this month’s Financial View, we look at how your contribution rate will have a meaningful impact on your final number.
In the recently released Sanlam Benchmark Survey for 2023 they state that “Less than10%of retirees can maintain their standard of living before retirement, due to under-saving and not preserving their assets.”
Under-saving can mean two things. The first is not saving for long enough but the second is saving too little. Conventional industry theory in South Africa states that if you save 10% of your salary towards retirement for at least 40 years you should be able to adequately maintain your standard of living in retirement. In general, we find that if a person has contributed consistently throughout their working life and not withdrawn when changing jobs, they will have sufficient to retire on, be they a Teacher, Librarian, Policeman or a Pilot.
The measure to maintain a standard of living is for your starting pension payout to be at least 75% of your final salary. There will be saving of certain costs once you retire (transport and contributions to your retirement fund), however as you age your medical expenses will escalate rapidly. The clever actuaries at Discovery generated a rule of thumb calculation which is easier to calculate and say that your retirement capital at retirement needs to 200 times your final monthly salary. And from there you will be able to generate a pension that will maintain your standard of living. So, if your final salary is R50 000 per month, you should have retirement savings of R10 million and from there you can generate a monthly pension of R37 500 that will increase each year to accommodate for inflation, and that you should not run out of savings while you are alive. It is scary to contemplate what happens to you if you do extinguish your retirement capital, as the options and support base in South Africa are very limited if you have to rely on our very meagre Older Persons Grant.
As mentioned, industry theory states that you need to contribute 10% of your salary each month to retirement savings for a period of 40 years. So, let’s use Archibald Andrews as an example. Archibald starts working at the age of 25 and plans to retire at 65. He starts on a salary of R10 000 per month and each, and every, year he receives an inflationary increase of 6%. This means that when Archibald reaches 65 his final salary will be R97 035 per month. Per the rule of thumb Archibald requires R19.4m in retirement capital to retire comfortably. Consider just how large that number actually is but it is not insurmountable and with proper planning and contributions, Archibald can get there.
If Archibald invested 10% of his salary into retirement savings each month, and never touches the money through a withdrawal he will reach retirement with R20.6m in his pot (assumption of inflation plus 6% for investment returns). But say Archibald only invested 5% of his salary in each month – his pot will half to R10.3m and he will not be able to retire comfortably. This is unfortunately the situation many South Africans find themselves in – they have saved diligently for the correct amount of time, they have invested in the correct asset classes, however they just haven’t put enough away.
One can see the exponential growth in both graphs and that is power of compounding. The benefit of compounding is the eighth wonder of the world according to Albert Einstein. Those that understand it earn it those that don’t pay it. One can also see that if the graph was continued beyond 40 years the gap would just continue to widen between the outcome from contributing 10% of salary compared to 5% of salary.
The figures in the Archibald Andrews example may seem very big and one can ask how R10m can be insufficient for retirement. That is a demonstration of the erosive power of inflation and how inflation attempts to make all of us poor. In order to protect the investor, they will require sufficient exposure to real growth assets. That is definitely a topic for an article of its own.
Recent Comments