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Retirement Planning
Monday, November 1, 2010
Putting pen to paper

For most people, planning for retirement is often neglected because of the complexity involved with having to answer the question: "how much money must I save every month and where do I invest it?"

Comments Mark Seymour of Alphen Asset Management, “The only way we can retire financially secure is by way of ownership of an asset, which either delivers an income or can be sold for cash. The plan of action therefore needs to entail the accumulation of capital.
He says the most common method of arriving at retirement with sufficient capital is by making savings every month. Other methods include: receiving an inheritance; realising a great idea in the form of a company and selling it; or, borrowing money and investing it in such a way that the return generated exceeds the financing costs.
Successful retirement planning requires the input of many variables such as:
a) Current age
b) Age at retirement
c) Life-span
d) Current net worth
e) Amount of monthly income required at retirement
f) Return generated on savings before retirement
g) Return generated on savings after retirement
i) Expected rate of inflation, and
h) How much you can afford to save.

These nine variables are sometimes difficult to determine and will change over time, which is why planning for retirement needs to be an iterative process and requires the sound input of a qualified financial planner.

How do these variables interrelate?

“The younger you are, the greater the role ‘compounding return will play in determining the success of your retirement plan,” says Seymour. “Retiring later will also be an advantage because there will be greater savings made and the time to spend your capital will be less. The longer your life span the longer your capital will need to last. The larger your net worth (assets minus liabilities), the better your chances of being able to retire financially secure. The smaller your income requirement, the more likely your capital will last your life span.”
The return on your investment pre- and post-retirement has the largest influence on whether your goal of retirement is successful or not. The rate of return of your savings will be constrained by your ability to tolerate price fluctuations. For example: equity returns, which have historically achieved an annual real return of around 7%, is prone to price collapses of 50% from time to time (even when valuations are favourable); whereas a much lower risk investment may limit draw-downs to 5%, yet only achieves returns just above inflation.
“Secondly, your knowledge of investing and the trust you have in the investment process will constrain potential returns. The greater the trust you have in your investment process and/or manager's ability will result in fewer investment changes, which will reduce the chance of locking in losses.”
Cost is also a very important factor. “It must, however, be recognised that good service is worth paying for,” he says. The costs incurred will include: administration fees, investment manager's fees, financial advisor fees and a Linked Investment Service Provider fee (if the investment is not made directly with the asset management company).
Seymour says that inflation has a large bearing on the success of your retirement plan because it erodes the purchasing power of your invested capital. “It is for this reason that the rate of return of your investment needs to exceed the rate of inflation. Secondly, your retirement income needs to be increased at least at the rate of inflation to ensure you maintain your living standards.
“Another important aspect of planning for retirement is adhering to a disciplined budget. Spending less than you earn is the only way for you to ensure that you have any money to put towards saving.”

Practical example

The best way to illustrate the importance of some of these aspects is to make a graph of capital projections for individuals with different monthly savings and different retirement ages, and so on. “In our example I consider three individuals (Conrad, John and Keith) who are each 35 years old, have R2m worth of capital to invest and need their capital to provide an income up until the age of 95.
As can be seen from the graph the capital for each of the individuals lasts the length of their life span. John has a higher income need but manages to meet this requirement by retiring at the age of 64 instead of 60. Keith manages a higher income requirement by saving R3 200/month leading up to retirement as opposed to his friends who don't make any savings.
“Planning for retirement is possible,” he says. “Put pen to paper and define what you hope to achieve in terms of when you want to retire and what your retirement income need is. Do a budget and work out how much you can save every month.
“Once you have these values you can then work out what investment returns you require (post costs). Have your investment knowledge and have your tolerance levels for different investment types and styles checked to see whether you can remain invested through different market conditions. Most importantly make contact with a competent financial advisor who can guide you through these steps on an ongoing basis.”

Copyright © Insurance Times and Investments® Vol:23.11 1st November, 2010
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