While you should effectively take advantage of the benefit of compound interest while retirement is still far off – compound interest is when interest earned on the money you save accrues interest itself, this essentially causing your funds to snowball – there are many other factors to be aware of when planning your retirement. It is also vital you choose the right savings vehicle to suit your needs.
Jeanette Marais, director of distribution and client service at Allan Gray, says: “When investing for retirement, it is important to plan for future increases in prices and future increases in your standard of living.
“Price inflation is a general increase in prices and a corresponding fall in the purchasing power of your money. Salary increases that keep pace with price inflation allow you to maintain a fixed standard of living over time.
However, salary increases that exceed price inflation may increase your standard of living and therefore your cost of living. You can think of this as ‘lifestyle inflation’, which is the increase in your standard of living over time.”
She says that as you become accustomed to a certain lifestyle, you will need to increase your retirement savings to maintain this standard of living, or otherwise risk spending ?far beyond what your retirement savings will allow.
Another factor you need to keep in mind is market volatility – this can affect the longevity of your savings. While market volatility is to be expected – it is a normal part of investing – it is something you need to take into account and effectively combat to ensure optimal performance of your retirement vehicle.
“To achieve above-inflation [real] returns, you need to be comfortable taking on some risk. History has shown that over the long term, equities provide the best return. While returns do not come in a straight line, fluctuations smooth out over time. If you invest in equities, you need to be comfortable with a bumpy ride,” says Marais.
Spreading your risk by investing in various sectors and industries will ensure you are adequately equipped to tackle market volatility.
Says Mark Lapedus, head of product development at Liberty Investments: “Market conditions in general have an impact on all investments including retirement savings. Inflation will contribute to the client’s income goal increasing over time and market volatility will affect the value of the savings and, as a result, the benefit that this can produce.
“Having said that, this is not necessarily a bad thing – consider a client who only invests in cash where the volatility is very low. He will probably have a worse outcome over the long term, compared with a client in a portfolio that can produce returns ahead of inflation even if the portfolio is volatile.”
Keep in mind, says Braam Fouché, financial adviser at PSG Wealth, that investment returns are a net result of asset allocation – your choice of assets – less fees. He says you need to “ensure your savings vehicles are cost-effective, completely transparent and reviewed regularly, with a clear indication of contributions, costs and returns. Some companies furnish you with an elaborate annual statement that includes all but your real results.”
It’s never too late to save – ensure your financial independence during retirement by starting today. Do this by consulting a financial adviser and looking into savings vehicles.
Says Fouché: “Through careful planning and allocating your capital to diverse assets, you can achieve a comfortable retirement. Savings are not only the fixed debit-order or employment-based retirement plan you sign up for, but also the assets you acquire, like property and equity, along the way. The combination of these plus personal savings and employment-based savings should be focused collectively to generate this exact result [a comfortable retirement].”
The power of compound interest
Michelle Dubois, legal specialist at Liberty, says: “The longer you delay to start your savings plan, the more you are going to have to save. Using a basic future value calculation, we can compare two 20-year-olds who wish to retire at the age of 60. Client A saves R1 000 a month from the age of 20 to the age of 30. He then stops contributing but leaves the funds invested until he reaches 60. Client B, on the other hand, saves R1 000 from the age of 30 until he retires at 60.
“Assuming a growth rate of 10% for both A and B the results are as follows: Client A will have saved a total of R1 000 x 12 months x 10 years = R120 000. Client B will have saved R1 000 x 12 x 30 years = R360 000. At the age of 60, Client A will have capital valued at R4m, whereas client B will have only R2.3m. This shows the cost of delay.”