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Retirement Planning
Wednesday, August 19, 2015 - 02:16
Go for high equity portfolio

With life expectancy in South Africa on the rise, it has become increasingly important for investors to reconsider their investment approach at retirement to ensure they are able to live out their golden years in comfort.

According to a recent study by Stats SA, the average life expectancy in South Africa has risen to 61 years by 2014 – an increase of nine years since the low in 2005. More to the point for retirement investors, the latest annuitant mortality data released by the Actuarial Society of South Africa reveals that the average life expectancy of a 65 year old South African who has an annuity is 86 for females and 82 for males.
“This means that contrary to popular belief, most retirees are still long term investors and need to have a long term approach to their living annuity investments,” says Tracy Jensen, Chief Product Architect at 10X Investments.
A living annuity is an investment product that provides former retirement fund members with an income from their savings. It allows them to select their income each year (subject to regulatory limits) and how their money is invested.
Jensen says that when it comes down to choosing a living annuity, investors should consider a portfolio that has the highest probability of sustaining the required income over their expected lifespan. “Although living annuity service providers offer extensive investment choice, investors essentially choose between a low, medium or high equity portfolios.
“A high equity portfolio holds mostly growth investments (shares and property), which offers a high expected long-term return, although this may be volatile in the short to medium term. Conversely, a low equity portfolio holds mainly defensive investments (bonds and cash), which provides lower long-term returns but is more stable over the short term. A medium equity portfolio sits between the two.”
Instinctively, most investors choose a low or medium equity portfolio, to preserve their accumulated savings in the event of a market correction. This may however not be the optimal choice.
Jensen notes that living annuity investors – especially recent retirees - have time on their side to ride out market volatility. “Investors who owned a high equity portfolio prior to the financial crisis of 2008 and had drawn a regular monthly income, would still have more money today than if they had been in a medium or low equity portfolio over the same period. This challenges the conventional thinking that it is safer to invest in a lower equity portfolio when drawing an income.”
Jensen says that focusing only on market volatility ignores the investor’s bigger risk, which is that they may eventually experience a drop in income and therefore in their standard of living.  “Investors can counter this risk by earning a higher long-term return.”
“The seemingly small difference in real (after inflation) returns between a medium and high equity portfolio can make a significant difference over a long-term investment horizon,” says Jensen. “A higher return can significantly increases the longevity of investors’ savings.”
Looking at data between 1900 and 2013, Jensen points out that moving from a low to medium equity portfolio will, on average, add 2% per year in returns over the long-term. “Moving from a medium to a high equity portfolio will add a further 1.7% per year in returns over the long-term. While these may seem small numbers by themselves, in the context of a 4% - 6% annual draw-down rate, it is easy to see how the additional return significantly impacts on how long savings last.”
Jensen explains that moving from a low to a high equity portfolio, an investor would be able to draw the same income up to 29[1] years longer, assuming average historical market returns, due to the higher long-term return earned by the high equity portfolio.
As an example to illustrate this, consider an investor who draws an income of 5% of their capital, growing annually with inflation. At some point, this draw-down may exceed the regulatory limit of 17.5% of their capital. When this occurs, the investor’s income growth will no longer keep up with inflation and they will experience a drop in living standard. In a high equity portfolio with low fees, this will occur on average 49 years after the investor has retired.
In contrast, if the investor had invested in a medium equity portfolio paying a high fee, on average their income would already drop 18 years after retirement. Jensen uses the graph below to illustrate the impact that fees and investment portfolio have on a living annuity:
As a word of caution, Jensen adds that as much as investors often have the flexibility to switch portfolios, doing this too frequently can negatively impact on an investor’s returns.

Copyright © Insurance Times and Investments® Vol:28.8 1st August, 2015
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