Know Your Money with Bronwyn Waner and Craig Finch
Know Your Money with Bronwyn Waner and Craig Finch
126. Inflation, Longevity, and Market Timing: The Retirement Triple Threat
Retirement planning goes far beyond building a substantial nest egg. As our guest Amika Gordon from Coronation Fund Managers explains, successfully navigating your post-retirement years requires understanding three critical risks that could derail even the most robust financial plans.
The first risk—inflation—is aptly named "the silent killer" for good reason. At a 6% inflation rate, one rand today will only purchase 17 cents worth of goods in 30 years. This erosion of purchasing power can devastate retirement savings unless your portfolio consistently outperforms inflation. Amika emphasizes that equities have historically been the best asset class for beating inflation over extended periods, making them an essential component of any post-retirement strategy despite their volatility.
Longevity risk presents another significant challenge as medical advances continue extending our lifespans. Many retirees underestimate how long their savings need to last, often planning for 15-20 years when they should prepare for 30 or more. This extended timeline affects both portfolio construction and sustainable withdrawal rates, with research suggesting an initial drawdown of around 5% can maintain capital adequacy throughout a three-decade retirement.
Perhaps most overlooked is sequence of returns risk—the potentially devastating impact of retiring just before or during a market downturn. Since no one can predict market timing with certainty, portfolios need to balance growth potential with volatility management through careful asset allocation and diversification. This explains why financial advisors recommend different investment strategies for pre-retirement accumulation versus post-retirement income generation.
The conversation offers practical insights for creating resilient retirement plans that can withstand these often-underestimated threats. Whether you're approaching retirement or already there, understanding these risks and implementing appropriate mitigation strategies could mean the difference between financial security and running out of money when you need it most.
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Hello everybody, welcome to Know your Money. I'm Bronwyn Wehner.
Speaker 2:And I'm Craig Finch, and we are from Growth Financial Planning. We hope you enjoy our podcast.
Speaker 1:Hi everybody. Today Amika is back us and she's from Coronation. She'll introduce herself. We had a question from one of our clients to say how should they plan for retirement, post-retirement, and we thought a great topic that you can cover today is what are the risks that they should factor into the part of their post-retirement planning risks?
Speaker 3:that they should factor into the part of their post-retirement planning. Welcome, Amika, Thank you. Thanks, Bronwyn. So yeah, my name is Amika Gordon and I'm an investment specialist with Coronation Fund Managers. I've been with the business for almost 12 years a long period of time and one of the things we are very passionate about is making sure that clients have good outcomes from their investment portfolios, particularly so that they can retire comfortably one day.
Speaker 3:But returns are sort of one side of the equation. You've also got to manage risks on the other side of the equation, I think, particularly in the post-retirement space. So once clients are retired, there's three key risks that we think they should be acutely aware of, and being aware of those will guide them in terms of making good decisions on how they put their post-retirement portfolios together. So the first risk is inflation risk. So, simply put, this is the risk that your investment portfolio, once you get to retirement age, doesn't grow ahead of inflation. So remember, inflation is just the rise in prices from year to year.
Speaker 3:But if your portfolio doesn't keep pace with inflation, what happens is you lose what's called purchasing power. Now, purchasing power very simply is how much of goods and services you can buy with one unit of currency. So if I had one rand worth of assets, how much of goods and services I can buy with that? What inflation does is it erodes that over long periods of time. So to give you a great example numerically, if we assume that inflation is going to be 6% over the next 30 years, I had one rand today. That one rand in 30 years time could only buy 17 cents worth of goods. Now that is what inflation does.
Speaker 1:So, for example, a hundred rand can get you a milk, a bread and this, and in 30 years time it can't even get you the milk. Is that what you're kind of saying, Exactly?
Speaker 3:So that is called erosion of purchasing power, where your money can no longer buy you the same amount of goods and services because prices have gone up. The way you try to protect against that is to invest your money wisely and make sure that the return that you get is ahead of inflation. That means that your money is growing in what we call real terms. So there's no point investing money and it grows at 5%, but inflation is at 7% because you still have the same problem where you can no longer buy the same amount of goods and services. So inflation risk is probably one of the biggest risks that investors face, whether it's a retirement portfolio or a discretionary portfolio, but particularly for retirees, who mostly get to retirement age. They don't have another source of income. The money they've got is all they have. They have to live off that capital for a long period of time. If that money doesn't grow ahead of inflation, they have this problem of reduced, diminished purchasing power, but high inflation has wiped out countries.
Speaker 3:It has. It's a very dangerous phenomenon. In World War II it wiped out.
Speaker 2:Zimbabwe Just inflation.
Speaker 3:I think it's coined the silent killer.
Speaker 2:Yeah, completely.
Speaker 3:In the short term you don't really see the effects. It's usually over long periods of time that you see the impact of inflation, compounded year in and year out.
Speaker 1:And I think it's kind of like what Warren was talking about when he said like the price of electricity or water going up 12%.
Speaker 2:yeah, exactly, but that's where our monetary policy in our country has been incredible how they've kept inflation under control. I think they've done a great job in that, against all odds.
Speaker 3:Yeah, so we've had very subdued inflation in South Africa, but I think the risk is making assumptions about what inflation will be in the future, anchoring off what it has been in the past and I think that's relevant for when you think about guaranteed annuities. So life annuities, where you make this investment into a life annuity that will pay you an income for life and the inflation risk there is. You escalate your income by call it 5%, which is the most popular way to do it.
Speaker 3:And what happens if inflation is 8% or 10%? We have runaway inflation. You're still no longer able to keep pace with your cost of living.
Speaker 1:So basically, in money terms, let's say you give 3 million rand to the life annuity and they say they're going to pay you 5,000 rand a month. You've given that 3 million rand. It's no longer yours, you have that 5,000 Rand. That 5,000 Rand will go up by 5%, but the value of that one Rand won't necessarily be five, because it's eight. So you'll be losing what you can buy.
Speaker 3:Absolutely so. You get your 5% growth in your income every year. So you think you're getting more income. But if your cost of living is going up by more than 5%, you're actually poorer off because the money think you're getting more income, but if your cost of living is going up by more than 5%, you're actually poorer off because the money that you're getting can no longer fund goods and services you need to purchase in retirement and our model portfolios.
Speaker 2:We've got benchmarks to beat inflation, plus 5% or whatever it is over the period of time, and that's what we look at all the time to make sure that's happening. And even if inflation in the 80s I know none of you were probably born in the 80s, but in that period of time it was around 20% so then the funds were doing 25, 28%, which is amazing returns, but they were beating inflation at the time. Now the funds are doing 12%, for example. It's still beating inflation by a long way, but still it beating inflation at the time. Now the funds are doing 12%, for example. It's still beating inflation by a long way, but still it's not 28%, but you're still in a positive territory because you're beating inflation. That's your point.
Speaker 3:That's exactly the point, and one of the ways to try and mitigate against inflation risk is to make sure, when you put your portfolio together, that you have the right mix of asset classes. So we talked about asset classes being equities, bonds, property, cash, local offshore. You have a well-constructed portfolio that has got enough exposure to what we call growth assets. Now, growth assets, by definition, for for us, are equities, property and commodities, excluding gold, and these are the assets that give you the best chance, over long periods of time, of beating inflation. So, if you look at any measure of performance of equities versus cash, versus bonds, over long periods of time, the best asset class to beat inflation and preserve that purchasing power over long periods of time has been equities.
Speaker 2:And equities are in our terms. Is you buy shares in MTN or Standard Bank? And the Standard Bank share goes up because their client base is getting bigger and bigger. They make more money and that money goes back to our investors. Who in one of your portfolios owns a little bit of Standard Bank? Is that right?
Speaker 1:Yes, I'm sorry, why excluding?
Speaker 3:gold. So gold is a more defensive asset. We classify it as a more conservative, defensive asset as opposed to a growth asset.
Speaker 4:What would be other examples of commodities then?
Speaker 3:So you can buy platinum, oil, rhodium, any of the metals. So those are all commodities. Coal, those are all commodities that you can have.
Speaker 4:Why is gold seen as defensive then?
Speaker 3:It's termed a safe haven asset, so people buy gold when they're worried about the state of the economy. You know it's got a store of value.
Speaker 2:It's almost a confidence thing as well. Because there's not enough gold in the world.
Speaker 3:There's a finite amount of gold in the world To cover what the value of gold is, kind of thing.
Speaker 2:So people think I'd rather have a gold coin in my pocket than a US dollar in my pocket, and that's where they go back to gold.
Speaker 3:Yeah, so we classify gold as a more defensive asset, so we exclude it from the growth asset.
Speaker 2:When constructing portfolios in the post-retirement space, we suggest that investors make sure they have a healthy exposure to those growth assets, because it's quite tempting to go into cash Because, especially when cash does well, you go, oh, oh, I can get cash, but then cash is not going to outperform as you said. Equity.
Speaker 3:So then short-term gain not long-term, absolutely Over long periods of time.
Speaker 2:No volatility, which is attractive, but you're going to get hurt later on.
Speaker 3:Because it doesn't deliver inflation-beating returns year in and year out over multiples of decades.
Speaker 1:And there is loads of research on that it's not like just some guess that people are saying it's true, 50 years of it at least.
Speaker 3:I mean, we've got stats that show 100 years worth of data and the value of one rand in cash is still one rand in cash, you know 100 years later, whereas if you look at equities it's hundreds of times you know it's what. So the best asset class to deliver those inflation beating returns over long periods of time is equity. So we suggest you have an appropriate amount of that asset class.
Speaker 2:So, for example, in your living annuity you should have X amount of equities in your portfolio. Yeah, and then and hopefully, those equities will always outperform inflation. So, no matter what inflation does, you're going to get a better than inflation return.
Speaker 3:So over long periods of time? Sure, absolutely. Remember. Equities have volatility, so in the short term prices move up and down, so you're not guaranteed to get that inflation beating return.
Speaker 1:But over extended periods of time, your best chance at beating inflation is to have equities in your portfolio, but that's why you have a basket of asset classes, because a portion of it will be in cash and a portion of it will be in equity, so that it's diversified and it can work out. Yes, okay, so that was risk number one.
Speaker 2:Yeah.
Speaker 3:The second risk is longevity risk, and here we what do you mean by longevity? So, here we're talking about how long you're going to live for.
Speaker 3:How long are you going to be in retirement for? So most people, when they get to retirement, sort of plan for maybe 20 to 30 years. We suggest planning for 30 years because people are living longer Medical advances, people are looking after themselves, people are living longer than they were decades ago. So plan for a longer retirement.
Speaker 3:In order to sustain a longer retirement, here too you've got to make sure that your mix of assets is appropriate and you also have a decent exposure to growth assets to keep that capital growing over long periods of time. So it's making sure your time horizon is appropriate. There's no point planning for a 15 year retirement and then you live for 30 years and then you haven't adequately catered for how long you're going to live for, right? So if you earn the side of caution and plan for a 30 year retirement, we think that's more appropriate. Linked to that is how much of income you draw from your living annuity to sustain that 30-year period. And here again, there's been lots of research done about what optimal levels of income are, and our research suggests that around 5% initial drawdown is sufficient to sustain a 30-year retirement.
Speaker 2:So that won't run out.
Speaker 3:In other words, if you draw 5%, whatever that is it'll take you 30 years before you hit your 17.5%, after which your capital starts.
Speaker 1:Warren, I don't know if you remember that 4% rule that we said.
Speaker 4:So if you take.
Speaker 1:Let's say you want 10,000 Rand in retirements, you times that by 300, that would give you 3 million. From that 3 million Rand you only want to draw 4%, or Mika's saying 5%. And if you drew 4% of 3 million it would give you 10,000 Rand a month. That 3 million Rand will would give you 10,000 rand a month. That 3 million rand will be able to then grow. So if this year it was 8% you'd have a little bit more than 3 million. But you're drawing the right amount down so that it lasts for 30 years. If you drew out the full interest, so the full 8%, it's back to that. 1 rand or 100 rand can only buy you milk and bread and would only buy you half the milk because your money is not worth what you need. So it's about that.
Speaker 4:I have a question relating to that from a bit earlier actually. So you were saying so. You said roughly 12% maybe is what a fund manager will return on your investment annually.
Speaker 2:It depends on the period. I'm just saying the last, just argumentatively On the last year.
Speaker 4:Yeah, let's call it 12%. What was inflation last year then?
Speaker 2:Well, officially, yeah, it's 3.5%, 3, 3.5%.
Speaker 4:Okay, so your real gain is not 12%. It's the difference.
Speaker 2:Yes, right, so If you can get inflation plus 2 over a 30-year period, you've done well.
Speaker 4:Inflation plus two.
Speaker 2:In any environment of inflation plus two.
Speaker 4:Okay, so there's real return over 30 years.
Speaker 2:You've done very well.
Speaker 4:Okay, so what would I know? This sounds obscure.
Speaker 2:So what's your?
Speaker 4:compound of that inflation plus two over 30 years.
Speaker 2:Well, I would have to do the numbers, but so it's a real return over the period. That's the important side of it. So you're going to have periods of time. Now, at the moment, we're in a low inflation environment, but we've been in the 20s, as I mentioned previously.
Speaker 4:And then the funds were doing 20 plus, why can't they carry on doing 20 plus? If they can do it, then why can't they carry on Well?
Speaker 2:because the companies aren't making those same amounts of profits, because of the environment, because of the inflation as well.
Speaker 1:So just back to that thing. If you said it was 12% and then it was 3%, let's just say 12 and 3. You've got 9%. It doesn't mean you must draw on that 9%, because this year it's 12 and 3. In 10 years' time it might be 20 and 2. Do you know what I mean?
Speaker 4:or 20 and 25, so inflation's 20 and 25. So that's why that's. I was just trying to define what the actual real value is, rather than saying you're getting a 12 return.
Speaker 3:So the real value is the difference between where real returns are so important because we're trying to consistently beat inflation. But the nature of financial markets is that you don't always get those smooth real returns every single year. We call it the lumpy nature of market returns, because some years you'll get 20 percent, some years you'll get negative 2 percent. But that's why focusing on the long-term and staying invested because it averages out Exactly.
Speaker 2:But that's your third point, right? If the share prices go down and you're in retirement drawing, yeah?
Speaker 3:We'll get to what we call sequence of returns, yeah, so, to sum it up, the way to manage longevity risk is twofold making sure you've appropriately planned for a longer time horizon and constructing your portfolio to make sure you have enough growth assets and that you have realistic assumptions around what returns are going to be and you have an appropriate starting income drawdown.
Speaker 2:And save early for the longer period. What?
Speaker 4:about that island in Japan where they live to like 110?
Speaker 3:What are they doing?
Speaker 4:there.
Speaker 3:And most people assume that their retirement period will be shorter than it actually is.
Speaker 4:You must always overestimate, surely?
Speaker 3:So the third risk that we think is important to understand, especially for retirees, that we think is important to understand, especially for retirees, is what we call sequence of returns risk. Now it sounds a little complicated, but all it talks about is the order in which you achieve your returns once you're in retirement. So no one has a crystal ball. We never know what financial markets, equity markets in particular, are going to do in a given year if your retirement coincides with an adverse market.
Speaker 1:So you retire the day, the year that.
Speaker 3:COVID Exactly. So, if you retired at the beginning of COVID, or you retired at the beginning of 2022, which was another crisis, or you retired at the beginning of 2008, when the GFC hit.
Speaker 2:Or 87 or 98.
Speaker 3:So if your retirement coincides with an adverse market environment where equity markets are falling, it can severely affect your retirement capital and how quickly you run out of money. Right, the problem is this is completely unknown. So you could get lucky and you could enjoy the first few years of great returns and then get the adverse returns, in which case you're better off. But if you're in the unfortunate cohort who happens to retire during a period where there's negative returns, like I said, it can severely deplete your capital over time.
Speaker 3:Now there's no sure way to avoid that because, like I said, you cannot predict what financial markets are going to do, but one way to try and mitigate some of that capital erosion is to invest in a portfolio that will experience lower volatility and have some element of capital protection. So the first two risks we talked about inflation and longevity we're focusing on making sure you have enough growth assets To cater for this risk. We're saying make sure you don't have too much exposure to growth assets, particularly equity markets, and make sure you're in a portfolio that manages volatility, because research has shown that if you're in a portfolio that manages volatility better and has some element of capital protection, even if you go through those negative market periods in the first few years, you will still come out better than had you been exposed to a portfolio that had no volatility management or capital protection.
Speaker 2:But also you might have cash that you've accumulated, that you could live off that for a during that period until the markets recover, and then you start drawing.
Speaker 3:So there's that way to structure.
Speaker 2:There's a financial from financial planning. There's lots we can do to help as well, and another problem is that well could be. A problem is if all your living, annuities, pension, is put into offshore.
Speaker 3:So that's, exactly.
Speaker 2:And the offshore is linked to the RAND volatility and the RAND drops, or gets better in value. And then you're subject to that, and that can be huge.
Speaker 3:And that's a question we get asked very often. Shouldn't we just have 100% offshore?
Speaker 3:in my living annuity because I've got the flexibility, I'm not restricted. The reality is, in your living annuity you do need to err on the side of caution. For the average investor drawing their 6% per annum, there's a concept called asset and liability matching, which means you have to have sufficient assets in your local currency to cover your local expenses. So you are drawing your six percent. You need to make sure that that income that you get is sufficient enough to cover your living expenses. The problem with having 100% exposed to offshore markets in a living annuity is that, yes, it's dollar assets, but it's denominated in rands, and so you're exposing yourself to currency fluctuations and the rand is one of the most volatile currencies in the world. So, again, if you have 100% exposed to offshore and it's all exposed to currency and the RAND strengthens, for example, and it is possible that the.
Speaker 3:RAND can have extreme strength in one year and the RAND strengthens, say, 15% to 20%, and you're now drawing your 6%. It's almost equivalent to markets falling to that extent because your capital is worth that 50% to 20% less.
Speaker 2:You can't have 100% equity as well. You've got to have some defensive assets in that portfolio Because you're trying to manage the sequence of returns risk.
Speaker 3:So I think in the post-retirement context, you have to have a more balanced and prudent approach to how you construct these portfolios because, in as much as equities over long periods of time give you your best chance at beating inflation and ensure sustainability of your capital, you can't have too much of it, because when you are drawing an income and relying on that income, you need to manage the volatility of that portfolio.
Speaker 1:I think how you can explain it is we have our model portfolios with Fundhouse. So we have our balanced portfolio, which is for the clients that are trying to accumulate the money for retirement. So if you kind of have a look at those returns, it's a lot more volatile. It's up and down because you're trying to grow now. So your period is 10 to 20 years. Once our clients then are in post-retirement, we have a balanced income fund, which is where you're going to be drawing an income from that. So if you put the two fund fact sheets next to each other, this one's doing really well because it's less volatile than this one. But you almost don't want this one to do. You don't want it to be volatile. Yes, you want that one to be volatile, you don't want this one to be volatile. So you have to just match it and move your money depending on where you're at and what you're doing with it Absolutely, and that's why there's different mandates with funds.
Speaker 3:So even at Coronation we have our balance fund, which is a pre-retirement savings vehicle, but once you get to retirement we'd suggest you'd use a different fund, Capital Plus, which is designed and structured in a slightly different way to cater for that income drawdown plus that need to deliver inflation plus 4%, Because there are different mandates. So that's why you have different model portfolios with different mandates to cater for different needs in your financial planning journey.
Speaker 4:I wonder one thing as time has gone on and there are more things you can spend your money on now, how does that concept apply to how you look at saving for retirement? Because again, if we go back into like earlier generations, there weren't so many things that we have today. I mean, my son is a great example when I was a little boy, versus me having a little boy now. I talked to my mom about it all the time. All the crap we can buy for him. It's ridiculous the mother's group fees that you pay to don't be part of a group, then you've got his swimming lessons, then you've got this, then you've got this, then you've got that. So there's just lots more stuff you're expected to pay for.
Speaker 2:But, oren, that's where the fund managers are. They're fortunate in a way because years ago Naspers wasn't a share to consider and Naspers owns a big chunk of a company in China called Tencent and Tencent they do a platform almost like Facebook and a lot of the kids in China that's their platform on Facebook. When I was little we didn't even have computers, never mind Facebook, but you had other things like commodities, like gold was a very big mining, you know gold mines.
Speaker 2:The fund manager used to buy the gold mines. Now they're buying like Apple and all those kinds of. They didn't have cell phones in those days and now the platforms. You've got these computer gaming scenarios that are just in the sky. So that's where the fund managers spend their life going to find new frontiers to invest for our clients money.
Speaker 3:Look. More choice is not necessarily a bad thing. It can be overwhelming when you have more choice, but I think from a fund management perspective, more choice means more opportunities. You just have to have the skills and the ability to cover those ideas and opportunities and implement them in a framework that also caters for risk and Money's got to be safe, all those kind of things. Exactly, but I don't think choice is necessarily a bad thing.
Speaker 4:No, I just think of it. Like you know, you say earlier in the other podcast we did, you mentioned how things were not static and they were dynamic. Projecting into the future is a hard thing to do, isn't it?
Speaker 3:It is. We always say, if it was easy, everybody would do it.
Speaker 2:Yeah, exactly.
Speaker 3:And there's forecast risk, and that's the risk that your assumptions are not going to play out the way you want to. But I think the best fund managers in the world get more right than they get wrong. It's not that they get nothing wrong.
Speaker 4:Understood and as technology improves. I know everyone likes to talk about AI now, but as that technology is moving forward at such a rapid pace, does it play more of an integral role in research and developing your ideas?
Speaker 3:It hasn't played that role for us necessarily. We haven't gotten to that point where we are replacing the human element of research.
Speaker 4:No, not replacing, but it does assist.
Speaker 3:We have started to use it to take notes, to summarize long documents, to create efficiencies in how we do things. But I think, given that our proprietary research is such a, it's the cornerstone of our investment process. You know, a machine or AI cannot replace that gut, feel you get when you speak to a company CEO or you speak to, you know industry participants and get a sense of what is going on with a particular sector and industry. So I don't think we would ever get to a point where it replaces but there's obvious efficiencies that are created through AI.
Speaker 4:Yeah, data-driven research and stuff like that. It's a lot easier to do it.
Speaker 3:Yeah, look, it depends on your investment process, right? There are portfolios out there that are more what they call quants-driven, which will rely on big data and processing large amounts of data to come up with ideas and filter ideas.
Speaker 4:It's very mathematical.
Speaker 3:We have a different fundamental approach to how we go about stock selection. Awesome. Thank you so much, it's a pleasure.
Speaker 1:Thanks, guys, thanks for having me. Thank you so much Once again. Thank you so much, thanks for having me.
Speaker 2:Thank you for listening. If you have enjoyed this podcast would like to subscribe. Please visit our website, wwwgrowthfpcoza. Information we have provided in this podcast is our personal opinion. For more detailed information, please discuss your financial situation with a financial planner.