A life annuity and a guaranteed annuity

unduhan-58The first thing to understand is that a ‘guaranteed annuity’ is not just one type of product. There is actually a range of different guaranteed annuity products, namely guaranteed escalation annuities, inflation-linked annuities, index-linked annuities and with-profit annuities.

Identifying which one is the right choice for you requires you to understand your current needs, your likely future needs, and the different benefits that each provides. This is best done with the help of a qualified financial planner who can analyse your requirements and match them to a product.

The one you choose will largely determine the starting pension for a specific lump sum, as each type of guarantee has a different ‘price’. You therefore have to think carefully about what you do and don’t need.

The other factors that will influence the size of the monthly pension you receive from your guaranteed annuity would be:

  • Interest rates (real rates or nominal rates)
  • The current level of the equity market (for index-linked or with-profit annuities)
  • Your age
  • Your sex
  • Expenses (initial upfront expenses, on-going expenses for administration)
  • Commission (to a maximum of 1.5%)
  • The additional features of your product, including whether you chose a guaranteed period, spouse pension, a death benefit and the choice of a thirteenth cheque every year.

With regards to your question on interest rates, these rates definitely influence the pricing. The higher the interest rate, the lower the pricing on a guaranteed annuity and visa versa.

At the time of purchase, therefore, the interest rate is important. Because higher interest rates will mean higher investment returns, the insurance company underwriting your annuity will be able to offer you more when interest rates are higher.

However, once you have purchased the annuity, any increases in your pension will depend on the type of product you choose. If you select a guaranteed escalation annuity, the increase will not be influenced by interest rates as the rate of increase is set from the start. Similarly, inflation-linked annuity increases are linked to published inflation by government, and so interest rates will play no part.

Only increases in index-linked annuities and with-profit annuities will be dependent on equity market returns and interest rates. Their increases are made in reference to how investments perform.

In deciding what is the best course of action for you to take, I would recommend that you speak to a certified financial advisor to analyse your requirements, risk profile and choice of annuity.

The right funds for a tax

unduhan-57I would like to congratulate you on your decision to use your tax-free savings account as part of your retirement planning. The biggest saving the tax fee savings account offers an individual is that you pay no capital gains tax when you withdraw money, and having a tax-free income can have a big impact in your retirement years.

The R500 000 that you are currently allowed to invest in a tax-free savings account during your lifetime is equal to investing R30 000 a year for 16 years and 8 months. The good news in your case is that if you plan to retire at age 65, your annual allowance will be invested for just more than 22 years before you start using it. That means it will be compounding during that time, and you will not have to pay any tax on the gains.

In order to maximise your return on your investment over time, however, you need a clear investment strategy to guide your decisions over time. You appear to appreciate this, as you mentioned that you do not want to make emotional decisions about your underlying investment funds.

You also realise that the investment environment has changed since last year. But if we assume that your investment period is nearly 40 years, we would expect things to change regularly over this time.

As a start, you need to write down your profit objective for your investment. You can then design an investment strategy that will give you the best chance of meeting this goal.

I cannot advise you exactly which funds to invest in, but I can give you some things to think about.

Your time horizon allows you the luxury to invest in more aggressive asset classes such as equities and listed property. Investing in these growth assets over a period of time gives you a high degree of certainty that you will beat inflation on average by 7% per annum. If you can handle volatility in the markets, then you can set that as your objective.

The next step is to design your investment strategy to be robust enough to cater for different market conditions. That means being exposed to different drivers of returns.

For example, the Divi index is essentially a value index and will perform well when that ‘style’ is being rewarded by the market. It however will also go through times when it under-performs, such as it did last year.

Similarly, there will be periods when local equity performs well, and other times when international equities deliver better returns. It is worth considering whether you should be always exposed to both, or if you can make informed decisions about when to direct your contributions to one or the other.

An important decision you need to make in this regard is whether you have sufficient knowledge of the markets to handle investments during different market cycles or whether you are prepared to pay a fee for a professional to handle your investments for you.

While crafting this investment strategy is vital, just as important is having the discipline to stick to it.  You should also have a system in place for measuring the effectiveness of your investment strategy over time.

Limited retirement capital

images-57I would highly recommend that this reader engages the services of a recognised professional financial planner. The information provided here leaves many more questions than answers, so advice is difficult.

The individual has a residence which she rents at R3 000 per month. She has R400 000 from which she needs to generate the rental income.

Sadly R3 000 per month represents R36 000 per year, which requires an income yield of 9%. This may be possible by purchasing SA Retail Bonds, which are currently offering 9.25% on a two year fix, but this would leave her very exposed to inflation. That means that if her rental escalates she will be required to spend capital. Given that she is currently only 68, the need to invest with a longer term outlook to beat or match inflation is critical.

Investing in another property may be an alternative, but the illiquid nature of this asset plus the tenant risk she highlights may offset the benefit of an escalating rental. In addition maintenance and repairs also have to be factored in.

Another alternative is a listed property or real estate investment trust (REIT) unit trust or exchange-traded fund (ETF). These funds would invest in listed property stocks on the JSE that generate income yield and also have the potential for capital growth.

The downside here, however, is that while the tenant mix is more diverse, commercially-orientated and subject to increases in rental income, the daily volatility of a property fund due to share price movements may leave the investor very uncomfortable from a risk perspective.

As for a fixed deposit, while there may have been some negative press around a number of our banking institutions, I am doubtful that the big banks are in any form of a crisis. They are well funded and run and it is unlikely we will see one of them fail in the near future.

However, even though she may be able to get a fixed deposit that offers the required 9% interest, she will have the same inflation problem that a retail bond presented. Her income will not increase even though her rental probably will.

I see two other options that may or may not be viable:

The first is to generate further income. The possibility of generating additional income from employment may allow for less income to be drawn from the investment and then the possibility of investing in a more growth-oriented portfolio.

The second is to consider engaging with her family around generational wealth planning. While this is often avoided at all costs by retirees, the reality is that it often only delays the inevitable. It may be possible to merge her situation with what succeeding generation’s lack. Parents lack cash flow and children lack capital. By planning together, there may be scope for both parties to benefit in the longer term. Sitting down a with a financial planner who can help you to come up with a potential solution around this proposal is essential.

Beyond these options, there are unfortuantely no ‘silver bullet’ options for retirees who have not prepared adequately. Their stories should however serve as an incentive to younger generations to start saving more, earlier!

Track with your retirement savings

There are many issues one has to consider before retirement, such as: How much debt do I have now and will I have any remaining at retirement? Are my kids still at school and will any of them need financial assistance when I am retired?

The most compelling question for a retiree is however: Am I going to be able to afford to live a comfortable lifestyle off the pension amount I receive?

Situations are different for every one of us, which is why it is very important to sit down with a financial advisor well ahead of retirement age. This will allow the necessary time to determine if your income will be enough in context of the potential expenses you may incur during your retirement years. Expenses may include items such as groceries, medical aid, rent or bond and fuel or transport money.

When a client asks me if they have saved enough for retirement I can only give a comprehensive answer if I have the following information: their current income and expenditure, and their contribution rate towards their pension fund and/or retirement annuity.

In addition, I need to know their planned retirement age, marital status and number of dependants. I also have to have an in-depth discussion about the type of lifestyle they envisage having in retirement.

I then use all this information to inform our discussion around possible annuity choices, as this also feeds into whether the level of savings will be adequate. There are different ways to structure your income in retirement, and these come at different costs.

Based on the information the reader has provided, it’s impossible to say whether, in his personal case, he is on track. I would rather advise him to sit down with an adviser who would have the appropriate financial analysis tools at their disposal to come up with a comprehensive analysis. They would be able to calculate, based on his current level of savings and projected retirement age, whether he could retire with an adequate amount of savings.

Following that discussion, the reader could then take some remedial action if it’s needed. That could be in the form of additional contributions to his retirement annuity, increasing his savings period by planning to retire later, or by revising his expenditure.

It’s never too late to take action. What’s important is making informed decisions about what you need to do.

Financial education for beginner

Six months after launching, the highly popular Wealthy Ever After financial education course is moving into the corporate market, having delivered 9 000 hours of content to users.

Co-developed by JSE-listed media group Moneyweb and The Money School, Wealthy Ever After is an online financial education course aimed at empowering people to take control of their finances. Used in conjunction with webinars and on-site education sessions, it forms a part of a powerful education tool.

“This course represents a major investment for Moneyweb and it is pleasing to see the take-up of the product by both individuals and corporates,” says Moneyweb Managing Director Marc Ashton. He adds: “Lack of financial education leads to poor money habits and this has a proven negative impact on productivity inside businesses and a direct impact on the bottom line.”

The challenging economic conditions add an extra layer of challenges into the mix, as staff grapple with rising interest rates, a higher cost of living and lower expected investment returns from property and equities.

“As employers begin to see the effects of the macroeconomic conditions filtering down into both the personal and professional lives of their employees, we’re seeing almost daily requests for training and assistance from corporates,” says Money School co-founder Hayley Parry.

“We’ve definitely seen an increase in enquiries within the past two months – including from companies that know that they’re not going to be able to provide employees with increases, or whose employees will be facing retrenchment within the next six months to a year.”

While the tough economy means that many businesses will be tightening their belts, financial education has a proven direct impact on the workforce and should not be ignored.

According to the 2015 PwC Employee Financial Wellness Survey:

  • 35% of ‘Generation Y’ employees find it difficult to meet household expenses on time each month
  • 30% find it difficult to make their minimum payments on their credit cards
  • Less than half (43%) are confident they will be able to retire when they want to

Gary Kayle, Money School co-founder says: “As money coaches, we know that there are many external factors which employers and employees cannot control when it comes to money. But what they can do – is help employees translate their hard work and effort into debt elimination and wealth building activities. That is something that is within their control and there has never been a better time for employers to showcase that they care about their staff’s financial wellbeing.

“You only have to see the testimonials and feedback we receive to understand the massively empowering impact that this has on staff morale and productivity.”

Advisor market heats up

While the market for robo-advisors in South Africa is still in its infancy, competition is quickly heating up – in line with global trends.

According to Bloomberg, robo-advisors manage roughly $50bn of assets globally, a figure that is expected to skyrocket to more than $2trn by 2020. Yet, a 2015 report by The Boston Consulting Group puts the global value of “professionally managed assets” at $74 trillion in 2014.

Broadly speaking, robo-advisors are online tools that use software to guide investors to compile an investment portfolio suitable to their specific needs and risk profile, without the help of a traditional human financial advisor. This approach is meant to simplify and reduce the cost of investing, but may not be sophisticated enough to provide guidance with complex investment structures.

Locally a number of players participate in this space (SmartRand and Yellowtail’s Figlo come to mind) and Sygnia has also announced plans to launch a robo-advisor service.

Peter Armitage, CEO of Anchor Capital, expects all the major asset management companies to come to market with various iterations of a technology-based solution, including the likes of Sanlam, Old Mutual and Allan Gray.

“I think the one thing you know for certain is that the whole industry landscape is going to be very different in a year or two’s time. So it is a case of being out there and learning – seeing what others are doing, seeing what consumers want, what works for them [and] where their appetite is,” he says.

Anchor Capital has just been appointed as the asset manager to new robo-advisor service, Bizank. Bizank is majority-owned by its founders, including fintech entrepreneur Adam Oberem. Anchor has a minority stake.

Investors can invest a minimum of a R1 000 a month or a R10 000 lump sum with Bizank.

The whole process is managed online. Bizank would identify appropriate investments for the client in line with his or her risk appetite and invest the money in a range of Anchor products or a segregated portfolio, Armitage says.

Investors would be able to monitor the performance of their portfolios continuously and Bizank will provide updates to show whether clients are meeting their goals. Fees range from 1% to 1.25% per annum (excluding VAT) depending on the underlying investments.

Armitage anticipates that the offering would initially appeal to younger, tech-savvy type investors who are prepared to interact without human intervention.

“I don’t think this is going to have a material impact on the more traditional financial advisor-type space, with much wealthier clients. So I think it is going to be for people who embrace technology and the way it is changing the world and we would anticipate probably the 25 to 35 age group being the initial target market.”

The expansion and growth of the offering will be a combination of learning from local as well as offshore developments.

Armitage says South Africa typically tend to be three or four years behind the rest of the world and local participants can follow trends, new technologies and value-adds emerging internationally.

While he believes the number of clients signing up could be significant, he doesn’t expect it to make a material contribution to Anchor Capital’s assets under management for quite some time.

The expected profile of a Bizank customer is someone with between R10 000 and R100 000 to invest and who it still “early” in his or her investing career.

“I don’t think it is going to be massive numbers right up front, but it is a gradual process. I have got no doubt that technology will change the industry over time and we want to make sure that we are positioned for that growth whenever it happens.”

Asset funds benefited investors

At the end of 1999 asset allocation funds comprised 6% of the unit trust industry. Asset allocation funds are also referred to as multi asset funds. They are funds that invest across the asset classes; equities, cash, bonds, and listed property – be they local or offshore. According to statistics from ASISA (the association for savings and investment South Africa), multi asset class funds comprise over 51% of the industry as at the end of 2015. Inflows into multi asset class funds remain strong which suggests that the trend towards these funds remains firmly in play.

One reason multi asset funds have become popular was the introduction of the FAIS legislation in 2004. Clients could now take incompetent advisers to the authorities and hold them to account for inappropriate and bad advice, including unsuitable asset allocation. Many advisers opted to use funds where the fund manager makes the asset allocation decision, and focused on ensuring that the chosen funds were suitable for clients based on some kind of risk analysis.

Growth oriented multi asset funds

Multi asset class funds suitable for growth investors would be those in the SA-Multi Asset-Flexible, SA-Multi Asset-High Equity, and Worldwide-Multi Asset-Flexible categories. These are the typical balanced and flexible funds. A growth oriented investor is likely to have a big chunk of their portfolio invested in the JSE, so I have compared the performances of these funds (on average) to the JSE. While the JSE has outperformed the three sector averages, it has done so at significantly higher levels of volatility. The Sharpe measure which considers both risk and return metrics shows that the multi asset funds all did a much better job of converting risk into return.

Teach your children about money is important

Unfortunately money is one of those taboo subjects that many people don’t like to talk about, whether they are big earners or small earners, big savers or those that don’t save at all. However, the earlier your children are exposed to the subject of money, the better.

There are a number of financial lessons that you can teach your children that will provide them with the responsibility they need and which won’t come across as “preachy”.

Start by opening bank accounts for them. This gives them the responsibility of managing their own money in a more formal, structured way. It also provides an obstacle to using the money as they will have to withdraw it out of the account.

Secondly, teach them the value of money and the importance of budgeting for how to spend it. A good place to start is that instead of just handing out pocket money assign them chores that earn them certain amounts and pay the income into their bank accounts. They have now earned the money, so it is more meaningful to them and they are less likely to spend it on things they don’t need.

Explain to them that they only have what they have earned and they cannot spend more than this. This is the beginning of teaching them how to budget, and hopefully how to save.

It is also important to teach them the difference between wants and needs. Needs are things you have to have on a daily basis, while a want in teenage terms is instant gratification. Show them the importance of delaying their wants and the benefits of saving and compound growth.

Albert Einstein called compound growth “the greatest mathematical discovery of all time”.  It is something that deserves to be understood.

Compounding is the process of generating earnings on an asset’s reinvested earnings. To work, it requires two things: the re-investment of earnings and time. The more time you give your investments, the more you are able to accelerate the income potential of your original investment. The perfect time to start saving and benefiting from compound growth, therefore, is when they are young.

As an example, consider two individuals, John and Jane.

When John was 15 he began investing R500 per month into a unit trust at a growth rate of 9%. For simplicity, let’s assume the growth rate was compounded annually. When John reaches 30, the value of his unit trust investment will be R189 203. Of this, he would have contributed R90 000 and the investment growth would have contributed R99 203.

Jane on the other hand, had the full R90 000 lump sum to invest at the age of 15 into a unit trust. At the same annual growth rate of 9% compounded annually, the value of Jane’s unit trust investment at the age of 30 will be R327 823. That is R237823 more than she put in and R138 593 more than John.

Both examples illustrate that by saving and taking advantage of compound growth, the growth in savings actually ends up creating more for you than the amounts you put in.

Save for retirement if you have just 35

Employees in their twenties could be tempted to postpone saving for retirement for a decade or two, arguing that they would make up the shortfall later on when they earn a bigger salary.

Even where young workers do save from day one, the fact that many people don’t preserve their retirement benefits when they change jobs, effectively mean they also defer saving for retirement. More than two-thirds of pensioners who participated in Sanlam’s Benchmark Survey 2016 indicated that they did not preserve their savings when changing jobs and it is no surprise then that only 35% of the same group believed they have saved enough for retirement.

A research paper by David Blake, Douglas Wright and Yumeng Zhang called Age-Dependent Investing: Optimal Funding and Investment Strategies in Defined Contribution Pension Plans when Members are Rational Life Cycle Financial Planners investigates a retirement funding model that spreads the income earned as smoothly as possible from the time an individual starts working until the day she dies.

Discussing the implications of such an approach at the launch of the survey, Willem le Roux, actuary and head of investment consulting at Simeka Consultants and Actuaries, said quite controversially, the model demonstrates that the member would save nothing before the age of 35, but from age 35 she would save every increase received above inflation towards her retirement.

“So you are basically capping your standard of living from age 35.”

However controversial such an approach would be, at the very least anyone aged 35 and younger has no reason to bury her head in the sand in the belief that retirement is going to be tough, Le Roux said.

“In fact, the future can still be very rosy.”

But postponing will come at a cost. Based on the average member, contribution rates could get as high as 35% by the age of 60, according to the model.

Le Roux said as an actuary he wouldn’t recommend that everyone under the age of 35 should contribute nothing towards their retirement.

Saving is a culture and it would be very difficult to start saving large portions of your income towards retirement when you’ve saved nothing for a decade.

It would also be extremely challenging to cap your standard of living from age 35.

There are also other factors to consider.

Budget and your lifestyle must be balance

Let’s face it: we all want the lifestyle of our wealthy friends, neighbours or celebrities even when our own lives might be on the right track.  We never seem to have enough, unless of course we decide to change the way we think and how we measure our own success. That starts by living within our means – something that is not an easy decision for most of us to do.

I recently met investors who should have been very well off during retirement as they have managed to save more than R 20 million. Unfortunately, their lifestyle costs are so high that their money will only last for ten to 12 years after retirement.  They need to make drastic changes to their spending habits or retirement is going to be a difficult time for them.

How did this happen?

My sense of these investors is that they earned a great income and never once budgeted to save. Their saving was an accident and something that happened on an ad hoc basis because they never had a spending plan. Your budget is in constant competition with your lifestyle unless you keep it under tight control. Life is about making compromises, but you need to make sure that you take the negativity out of this process and look for positive compromises. What do you really want? Do you want to curb your grocery spending so that you can have one great meal eating out at that fantastic new restaurant? Would you like to send your child to private school or live in the bigger house? Drive the new shiny car or go on a holiday?

You need to decide what makes you happy and spend your money on this. That means you need a budget – something most people don’t have. Once you have worked out what you need every month to cover your lifestyle costs, transfer the difference in your transaction account to another account, where you won’t be tempted to spend it on frivolous items. Hopefully there is an excess in your budget and if there isn’t, get a third party to help you. You are the only one with an emotional attachment to your money and a pair of impartial eyes can help to make you think clearly about your money and to make smarter decisions.

And then you need patience. Once you have decided that you want to take that trip to Italy, you have two choices. You can go immediately and use your credit card or you can save and wait until you have the money to pay for the trip. If you have the cash available; a trip to Italy will cost you at least R 25 000 (as an example). If you decide to pay upfront with a credit card it will cost you between R 44 289 and R 64 843, depending on whether you pay it off in three or five years at an interest rate of 21% per annum. Most of us are able to stomach R 25 000 for such a trip, but R 64 843 is a bit rich. Patience has a real monetary value.

Patience is tested especially when you start to save for retirement. This is usually because we do not have an idea of what retirement will look like. We almost try to avoid it, because it reminds us that we are getting older. If you know where you would like to stay after retirement and what you would like to do with your time, the decision to save for it becomes far easier.

Lifestyle is important; this is how we live every day, but it must fit into your income. So figure out what you can do without to make the things that are really important to you, obtainable.