For many years, the retirement rule of thumb advised citizens to diligently save 15% of their earnings over a 35-year period in a growth portfolio; to generate an income sufficient to comfortably see them through their golden years.
But all ‘rules of thumb’ should be reassessed at regular intervals, or else we’re really just ‘holding thumbs’ in the hopes that they’re still as relevant now as they were 10 years ago, says Rowan Burger, head of client strategy at Momentum Metropolitan.
Testing the rule of thumb: reasonable returns
The current rule of thumb assumes the following: reasonable returns over the member’s working life, with monthly contributions covering 15% of earnings; at least 35 years of work (with no dipping into retirement savings when transitioning to another job); and a roughly 20-year retirement period.
To test the first component, we turn to the Johannesburg Stock Exchange (JSE) All Share Index (ALSI) to look at historical returns relative to inflation over the past few decades.
In the graph above, the red line represents the long-term investment growth requirement, while the black line shows the 20-year moving average – the assumed retirement period. The more volatile gold line reflects the 7-year moving returns; the average amount of time spent with one employer.
To provide for a decent retirement, we need returns to beat inflation – which is a guide for how your retirement expenses will advance. The higher your returns above inflation, the less you theoretically would need to contribute, as the compounding effect of interest would effectively save the money for you.
Consider that with every rand you spend in retirement, 33 cents comes from your contributions and a whopping 67 cents from your investment returns, demonstrating the power of this effect in action. To put it another way, you would have to double your saving rate to 30% if your investments are just beating inflation.
So the question is, has the equity market delivered the returns you need for a decent retirement?
Looking at the graph, in recent times, the answer is no. The gold line is well below the required 7% mark, while the black line inches downwards. Inflation is rising and with it interest rates, which will increase the cost of credit and stagnate economic growth.
Given the recent past performance and poor prospects, it seems likely that additional amounts will need to be saved to make good the shortfall.
35 years of work and a 20-year retirement: an outdated thumb-suck?
To determine whether a 35-year working life is enough time to provide for a decent retirement, we must interrogate the current retirement age of between 60 – 65 and the average lifespan. I’ve used a United States (US) example in the graph below simply because there are no clear stats available for South Africa, and the average American has a comparable life expectancy to a South African (similar levels of obesity and morbidity).
The shaded area represents the average retirement age, while the gold block indicates the retirement period.
One glance at the graph should give you an idea of the ‘problem’: We’re living longer and our working life is getting shorter. The catch? We need more savings to comfortably see us through the golden period.
In the early 1900s, you might have lived to around the age of 76, and you would be working for all of your time on earth. In 2010, and thanks to modern medicine, our life expectancy climbed to around 82 years, with the average retirement window being 17 years. If your retirement contributions amounted to 15% of your earnings and you saved consistently over the whole of your working life, you were probably in for a decent retirement.
But if we roll this forward to a 2040 projection, we would see the average life expectancy rise to 90, which would mean providing for 26-odd years of retirement. Fifteen per cent will no longer cut it – you would need to be saving approximately 30% of your monthly earnings.
We recognise that South Africans will struggle to set aside more for retirement savings. It seems clear we need to reverse the trend and start to move up our retirement ages along with the improvements in life expectancy. In South Africa, with our high levels of youth unemployment, this will of course raise interesting debates.
Rewriting the rules
South Africans are cash-strapped – for many, a retirement nest egg is their only savings. We’re seeing more and more people cash out their pension or provident funds when leaving a job, preserving nothing for their later years. Treasury has seen the dark clouds on the horizon and plans to introduce a two-pot system in a desperate attempt to keep the inevitable storm at bay, encouraging fund members to maintain some level of preservation.
However, while Treasury deserves a thumbs-up for this proposal, there will still be too little in the pot to comfortably see us through retirement.
So what options do we have? We need to get realistic about contributions – 15% will not leave us with enough money to retire comfortably at age 60 – 65, while contributing 30% or more of our monthly earnings is just not feasible for most South Africans.
If we cannot continue work with traditional employers, retirees will need a ‘side hustle’ or alternative income stream to see them through till at least the age of 70, stopping them from dipping into their capital.
With that said, it is clear that the retirement paradigm may need to be reconsidered in the not-too-distant near future if we are to avoid a Thumbelina retirement.
- By Rowan Burger, head of client strategy at Momentum Metropolitan