The advancement of medical science means that most people are likely to spend virtually the same amount in retirement as they did working and building up their retirement nest egg. This longevity places a huge amount of pressure on the retirement capital that is available when an individual stops working and significantly increases the importance of starting to save for retirement as early as possible.
By way of example, an average annual inflation rate of 6% means that if monthly expenses are R50 000 today for someone who is 40 years of age, expenses are likely to over to R160 000 per month by the time they reach the age of 60. Even during retirement, the impact of inflation will mean that expenses keep growing every year, touching R280 000 when they turn 70 and by the time they are 80 years old, will probably amount to more than R510 000 per month.
At face value, these figures may appear astronomical but they will be a reality if inflation continues at 6% per annum. While an income usually increases proportionately during a working lifetime, in order to meet the expenses for 30 years after you retire, an individual will need to have an amount of at least R10million to invest when they reach a retirement age of 65 years. This is assuming that at-retirement investment, the individual still earns above-inflation annual interest throughout their retirement.
What does all this mean? For one, it means that the money earned must work harder than ever in order for the retired to meet their expenses.
It’s also important to differentiate between saving and investing. While South Africans are notoriously bad at saving, there are some households that have savings accounts. However, this saved capital should not really be factored into long-term investment goals – especially retirement . This is because while a savings account is excellent for minor financial emergencies, the money is not usually being invested optimally as interest from fixed deposits or other pure savings facilities are simply too low over time to grow money enough to meet the needs of retirement. People’s propensity to save has also declined in the face of rising consumption and living expenses and it becomes clear that ‘saving’ for retirement is a very risky approach.
Therefore, what is needed is proper investment, linked to a clearly defined investment plan.
Such an investment plan has to focus on much more than merely whether to buy equities, debt or some other form of investment. Rather, it needs to be a goal-based approach to investing, where investments are segregated for each goal and monitored until that goal is achieved. Just as we use specialists like wedding planners, interior designers, nutritionists, physical trainers to meet our lifestyle objectives, goal-based financial planning requires special skill sets typically offered by the relevant financial professionals such as Certified Financial Planners (CFPs) and financial advisors.
Putting your money into a savings account is unlikely to earn you 10% per year growth, which brings us to the original question of whether equities need to be part of an investment plan to build the desired investment sum. A critical aspect of ‘asset allocation’ is deciding the amount of money allocated to different asset classes such as equities, bonds, and property, in a portfolio.
One way to decide asset allocation is by age and time horizon available to reach that goal. For example, a young person in his first job may be willing to take higher risk as he may have limited liabilities and responsibilities. On the other hand, a 50-year-old could have higher liabilities and responsibilities and may choose a portfolio with a slightly lower return, but with relatively less risky investments. Deciding the right asset allocation based on individual goals and risk appetite is very important in constructing a well-planned portfolio.
Having established that our money needs to work harder than ever to keep up with the rising cost of living and our longer lifespans, rather than asking whether equities are essential, we should be asking ourselves why equities are essential.
The answer is relatively simple. Equities have the proven potential to provide higher returns than most other investments over a period of time but due to the higher risks involved in getting these higher returns, equity investments should be chosen for longer-term goals, which are ideally more than five years away. As such, investment funds with a strong equity bias are one of the best ways to invest for the long term and, as such, should be considered an essential part of any well-planned and diversified investment portfolio.
Article credit http://www.riskafrica.com/equity-essential-retirement-investment-portfolios/