Retirement and your ‘second wind’

With improved healthcare and the trend towards healthier lifestyles, many people are living to a ripe old age.  Make sure that your money lasts as long as you do.

Are you retiring in the near future and concerned that you may not have enough capital to retire?

We often read that the majority of South Africans will not have enough money to retire.  This means that they either have to keep on working, or they have to change their lifestyle dramatically and live more frugally than planned.

For many people, this may seem like a major setback.  People who find themselves in this position often compound their situation through poor financial decisions after retirement.  If you are in this position, what should you do?  How does one make the best of a difficult situation?  There is no magic cure.

It is important to remember that people who retire at 65, on average, still have approximately 20 years to live.  This means that they have time to allow their capital to grow without taking unnecessary risks.  It is equally important to know that there is no miracle cure, but you can recover your situation with some careful planning.

Sadly, retired people have been the main victims of financial disasters over the last few years in pyramid schemes.  Those with longer memories will remember the Leaderguard and Masterbond debacles.

Retired people often have some investable capital, and they are in financial difficulty.  This combination is a recipe for disaster, as people who are under financial stress tend to make very poor decisions.  Remember that you have time to make your situation better, and that there are no magic financial pro-ducts to solve all your problems.

You should tackle this problem from a number of different angles.  The most obvious route is to continue earning income after retirement.  This does not mean that you must necessarily continue with your old job—you could start a second career.  Many retirees have started second careers that have literally changed their lives.

Good examples of second careers are estate agents, consultants, building superintendents, or even supervisors of small businesses, e.g. garden service companies.  Any income that you earn after retirement allows you to draw less of your capital, thereby giving you more time to let your capital grow.

It is highly likely that you will live longer than you expect, and inflation will have more of an impact on your finances than you thought.  This means that you need to invest your capital wisely and with caution.  You cannot leave your money in a bank account, as you will lose money in real terms, i.e. after inflation and tax.

It is also not recommended that you invest your precious retirement capital in a new business venture unless you are already very familiar with the industry.  I often meet people who have retired with insufficient capital who decided to use their retirement capital to open a shop or restaurant with friends or family.

This has usually led to disastrous consequences as the new business failed and left the retiree on the breadline.  Also, be very wary of investing a significant part of your capital into direct businesses—statistically they are more likely to fail than succeed.

Understand risk and return

People with insufficient capital at retirement usually try to increase their capital base as quickly as possible to make up the shortfall.  Unfortunately, many people choose investments with the greatest potential returns to make up the shortfall as quickly as possible.

The problem with this approach is that risk and return are always related: if you target higher returns, you are always taking higher risks.

If you have retired with insufficient capital, you cannot afford to take too much risk as you have very little room to manoeuvre if things go wrong.  In fact, you should take less risk than people who have retired with sufficient capital.

You should develop a well-constructed portfolio of assets that are diversified across cash, bonds, property, and shares.  The only ‘free lunch’ in the world of finance is diversification.  A properly diversified portfolio of assets creates the highest possible returns with the lowest possible risk.

An example of a diversified portfolio is 10% cash, 20% property, 40% bonds, and 30% shares.  The property in this instance is investment property, and does not refer to your residence.  The ideal combination of assets for each person will vary depending on their particular circumstances.

Do you need to own your house?

If you have very little investment capital and you have a house that is paid off, then you need to ask yourself if you really need to have capital tied up in a house.  Many people feel that you must own your house, particularly as you get older.  There are other experts who would argue that your home is just an expense, and that you should not have too much capital tied up in an expense.

You could consider selling your house and renting a property—but only if the capital that you realise from your house is invested in a very low risk portfolio.  This option may not suit everybody, and you should do your calculations carefully.

Whatever you do, don’t create debt at this stage in your life.  This means that you should not have credit card debt or even a mortgage—rather rent than have a mortgage.

Reduce your expenses

If you are able to reduce your lifestyle costs by a small amount, you will ensure that your capital lasts much longer.  People who reduce their expenses by 10% can make their capital last for an additional 4 or 5 years.  This means that it may not be necessary to change your entire lifestyle; some small adjustments may be enough.

Retiring with insufficient capital may not be a disaster.  You need to be sensible, however, and take care with the capital that you have.  Avoid taking unnecessary risks with your precious nest egg, and you may find yourself in a better position than anticipated.

Published in Personal Finance Issue 317 (June 2007).

Retiring at 65?  Who decided that?

Mark Henson, wealth manager at Investec Wealth and Management

I’VE OFTEN wondered why the normal retirement age is 65.  Who decided that this is the right age to stop working, and on what basis?  With only 5% of SA’s population able to retire and maintain their standard of living, a 95% failure rate can’t be right.

As a result, I’ve been questioning the legitimacy of this concept and whether age 65 is relevant in today’s world as a ‘normal’ retirement age.  From a financial perspective, the generally accepted industry norm is that you should spend two-thirds of your life in the accumulation phase saving for retirement, and a third in drawdown.

Through medical advancements, life expectancy is being pushed out all the time, so this is a dynamic reality and one that requires regular revision.  For example, a third of babies born in 2013 in the UK are expected to live to 100.  These developments require a change in the way we manage our finances.

When did the pension start?

The pension, as a concept, was born in the 1880s, when German Chancellor Otto von Bismarck was facing a social revolt and needed a mechanism to pacify the nation.  His solution was to introduce a social pension scheme which promised support from the government for older citizens.  Initially, 70 was chosen as the retirement age, but this was later lowered to 65.  Employers, employees, and the government would all contribute.

The challenge with the system at the time, from a societal perspective, was that life expectancy was a lot lower than it is today, so few people enjoyed the benefits of this scheme in its earlier years.  The US adopted a similar model more than 50 years later, and the magical number of 65 was also chosen—and in many instances, this is still in place today.

The world today is different in so many ways from what it was 130 years ago.  If the futurists are correct and the first person to live to 150 has been born, why is the normal retirement age still 65?

If we go back to the one-third, two-thirds principle for savings and dis-savings, the question arises: If I go on to live to 125 and I started working in my mid-20s, surely I should consider retiring at 90 years old?

According to the Mental Health Foundation, one in five of present-day retirees experiences depression.  This often happens because people lose the sense of purpose that working provides, or because they lose the social interaction of the workplace.  Those living alone because of bereavement or divorce are even more at risk, while physical health problems can also make people more vulnerable to mental health issues.

Recent studies have also indicated that retirement increases the chances of suffering from clinical depression by about 40%, and of having at least one diagnosed physical illness by 60%.

Written by Warren Ingram

This article is a general information sheet and should not be used or relied on as legal or other professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your adviser for specific and detailed advice. Errors and omissions excepted (E&OE).