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As volatile investment markets are exacerbated by the Coronavirus pandemic, it is apt that we highlight the issue of “sequence of return risk”. This is the long-term negative effect on retired investors if your retirement capital declines just after you retire, and you’ve started drawing a regular income.
The investment decline will result in a larger withdrawal from capital than if it had experienced growth, resulting in a position that one will need to draw a larger portion of capital over the coming years to achieve the same level of income. The ultimate result is the depletion of your retirement savings over a shorter period of time.
This scenario is best illustrated by an example from Coronation:
Consider two portfolios that will both generate average annual returns of 11% with drawdown rates of 7% per annum. Portfolio One’s returns for the first three years are: 14%, 29% and -7%. Portfolio Two’s returns for the first three years are: -7%, 14% and 29%. Portfolio One will produce sustainable income for 24 years and Portfolio Two will produce sustainable income for 16 years. This simple example illustrates that if your retirement date coincides with an adverse market environment, the impact on accumulated savings could be devastating.
This “sequence-of-return-risk” is purely a function of maths and ‘bad luck’. However, one can mitigate this long-lasting negative effect by ensuring you have an appropriate conservatively structured investment portfolio at the start of retirement.
One needs the right balance between income and growth assets to achieve growth after inflation (over the long term) and capital preservation in the short term.
In the current global low inflation rate environment, investors need to moderate their return expectations, and ensure that they are not withdrawing more from their Living Annuities than can be sustained. The globally accepted drawdown rate is not more than 5% per annum of invested capital in order to preserve savings over the long term.
A weak SA economy does pose challenges for investors
Although global inflation is forecast to remain low for a few years, higher long-term inflation in South Africa does pose a risk due to the country’s deteriorating finances. As the economy struggles to grow and government debt balloons out of control, foreign funding will become more necessary, which will come at a far higher price, weakening the Rand, and driving up inflation.
Therefore, it is imperative that your investment portfolio strategy does incorporate a Rand hedge component, which matches your personal risk profile. Speak to one of our Portfolio Managers to assist you implementing the appropriate strategy for you.