The biggest financial mistake a young person can make is believing that planning for their retirement is something they can worry about when they are earning better salaries in the future, or that their retirement savings are being adequately taken care of via monthly deductions by their employer.
“It is astonishing how many young people only save via their employers’ pension or provident funds and how many have no idea how much they are saving, where that money is invested, and in what,” says Jac de Wet, national head of sales at PSG Wealth.
There is often a mistaken belief that saving makes more sense once you are earning more and therefore have more disposable income to save. In reality, says De Wet: “As people are promoted and their salaries increase, so does their standard of living and their monthly expenses tend to go up in line with their increase in income.”
But retiring comfortably is first and foremost about the period invested rather than the amount, he adds. The most important thing to know is that the earlier you start, the less you need to save monthly.
And if you haven’t, catching up is not about catching up on the amount of savings you have missed out on in the past couple of years. It is really about catching up on the compounded returns you have missed out on.
To illustrate, De Wet says that if you want to retire with R1 million at age 65 and you start saving at age 25, you’ll need to save R180 a month (assuming a 10% annual return and not taking inflation into account). If you want to end up with R1 million at age 65 but only start saving at age 45, you will need to save almost R1 400 a month, so the longer you postpone saving, the more you need to save.
This is equally important for people working for themselves who need to fund their own retirement. Many tend to pump any money they make back into the business without making formal provision for retirement – but this provision is even more crucial for the self-employed as there is no employer making automatic retirement savings on their behalf. “The moment you formalise your retirement savings plan, and don’t deviate, the better the outcome at retirement.”
According to PSG Wealth, apart from starting as early as possible, to be part of the 6% of South Africans who are able to retire comfortably, you can actively plan and maximise your saving by following a few steps:
- Save more by cutting back on expenses and dropping your standard of living. According to PSG Wealth, an additional R1 million at retirement today buys you an extra R4 100 a month (based on an annuity rate of 5%).
- Allocate a higher percentage to growth assets like equities. De Wet says a rough rule of thumb is to deduct your current age from 100 (the age to which you could live), and the result is the percentage exposure you should have to equities. So, at age 40, you should have 60% in equities and at age 60, you should have 40% in equities.
- Preserve your retirement funds. Never take the option to cash out your pension benefits when you change jobs or get retrenched, and don’t be tempted to use your retirement savings for anything other than retirement.
- Make use of all the tax benefits available. All contributions to retirement annuities, pension funds or provident funds are tax-deductible up to 27.5% of your taxable income, up to a maximum of R350 000 a year. This is particularly important for those who are self-employed, De Wet says, and retirement annuities are an ideal vehicle for saving and making use of tax benefits.
- Work for longer, even if it is part-time after formal retirement.
- Get financial advice.
Given that the local equity market has not given positive returns recently, it has become increasingly difficult to convince people to invest for their retirement. But markets are so cheap at the moment. “People who start saving and investing now are doing so at the lower end of the cycle and the upside is much bigger than the downside,” De Wet says. “The upside and the opportunities, especially in South Africa, are phenomenal, with many quality companies trading on single-digit price-to-earnings ratios (P/Es). The potential upside far outweighs current risks.”
For those nearing retirement, De Wet says that if they can keep working for another few years – at a time when compounding their savings “really hits the ground” – the effect on their retirement savings will be immense.
The most important thing to do is to save first, then spend. “If you place your investments into debit orders and live with whatever is left, you are doing the right thing. If you can’t get by by doing this, cut back on expenses or get another income.”
De Wet says that a couple who recently retired from their teaching careers and were disciplined about their retirement savings from the start have retired with R40 million and are travelling the world now because they lived within their means.
“The direct result of starting early, and saving first and then spending is that you start the benefits of compound interest early –and the more money gets made for you, the less you have to save,” he adds.
“Successful investing is about accumulating easy wins and watching them compound over time. Small incremental returns, day after day, month after month.”