According to the Oxford dictionary, a “rule of thumb” is “a broadly accurate guide or principle, based on practice rather than theory”.
For many years, the retirement rule of thumb advised citizens diligently to save 15% of their earnings over 35 years in a growth portfolio, to generate an income sufficient to see them through their “golden years” comfortably.
But all rules of thumb should be reassessed regularly, or we’re just “holding thumbs” in the hope that they’re still as relevant now as they were 10 years ago.
Testing the rule of thumb: reasonable returns
The current rule of thumb assumes the following: reasonable returns over the member’s working life, with monthly contributions covering 15% of earnings; at least 35 years of work (with no dipping into retirement savings when transitioning to another job); and about 20 years in retirement.
To test the first component, we turn to the JSE’s All Share Index (Alsi) to look at historical returns relative to inflation over the past few decades.
In the graph above, the red line represents the long-term investment growth requirement, while the black line shows the 20-year moving average – the assumed retirement period. The more volatile gold line reflects the seven-year moving returns, the average time spent with one employer.
To provide for a decent retirement, we need returns to beat inflation (which is a guide for how your retirement expenses will advance). The higher your returns above inflation, the less you theoretically would need to contribute, as the compounding effect of interest would effectively save the money for you.
Consider that with every rand you spend in retirement, 33c come from your contributions and a whopping 67c from your investment returns, demonstrating the power of this effect in action. To put it another way, you would have to double your saving rate to 30% if your investments are just beating inflation.
So, the question is, has the equity market delivered the returns you need for a decent retirement?
Looking at the graph, in recent times, the answer is no. The gold line is well below the required 7% mark, while the black line inches downwards. Inflation is rising and with it interest rates, which will increase the cost of credit and stagnate economic growth.
Given recent past performance, and poor prospects, it seems likely that additional amounts will need to be saved to make good the shortfall.
35 years of work and a 20-year retirement: an outdated thumb-suck?
To determine whether a 35-year working life is enough time to provide for a decent retirement, we must interrogate the current retirement age of between 60 and 65 and the average lifespan.
I’ve used a United States example in the graph below simply because there are no clear stats available for South Africa, and the average American has a comparable life expectancy to a South African (similar levels of obesity and morbidity).
The shaded area represents the average retirement age, while the gold block indicates the retirement period.
One glance at the graph should give you an idea of the problem: we’re living longer (hoorah!) and our working life is getting shorter (another hoorah!). The catch? We need more savings to see us through the golden period.
In the early 1900s, you might have lived to around the age of 76, and you would be working for all of your time on earth. In 2010, and thanks to modern medicine, our life expectancy climbed to around 82 years, with the average retirement window being 17 years. If your retirement contributions amounted to 15% of your earnings and you saved consistently over the whole of your working life, you were probably in for a decent retirement.
But if we roll this forward to a 2040 projection, we would see the average life expectancy rise to 90, which would mean providing for 26-odd years of retirement. Fifteen per cent will no longer cut it – you would need to be saving about 30% of your monthly earnings.
We recognise that South Africans will struggle to set aside more for retirement savings. It seems clear we need to reverse the trend and start to move up our retirement ages along with the improvements in life expectancy. In South Africa, with our high levels of youth unemployment, this will raise interesting debates.
Rewriting the rules
South Africans are cash-strapped – for many, a retirement nest egg is their only savings. We’re seeing more and more people cash out their pension or provident funds when leaving a job, preserving nothing for their later years.
National Treasury has seen the dark clouds on the horizon and plans to introduce a two-pot system in a desperate attempt to keep the inevitable storm at bay, encouraging fund members to maintain some level of preservation.
However, while Treasury deserves a thumbs-up for this proposal, there will still be too little in the pot to see us through retirement.
What options do we have? We need to get realistic about contributions – 15% will not leave us with enough money to retire comfortably at age 60 or 65, while contributing 30% or more of our monthly earnings is not feasible for most South Africans.
If we cannot continue work with traditional employers, retirees will need a side hustle or alternative income stream to see them through to at least the age of 70, stopping them from dipping into their capital.
With that said, it is clear that the retirement paradigm may need to be reconsidered in the not-too-distant near future if we are to avoid a Thumbelina retirement.
Rowan Burger is the head of client strategy at Momentum Metropolitan.
Disclaimer: The views expressed in this article are those of the writer and are not necessarily shared by Moonstone Information Refinery or its sister companies.
In an ideal world, like all other 1st world countries, that sounds OK, but we are sitting here with a Govt that is fast running the country into the ground with no economical growth prospects that will sustain 30 % Retirement funds- what a farce and why even bother to print an article like this in RSA????? eish, the writer really lives in a dreamworld
Thank you for a very good article Rowan. The problem that I see with investing more money is, where do you invest it? I started my career with Old Mutual in 1988. At the time there were about 11 unit Trust funds in South Africa, Old Mutual Sage, Sanlam , GuardBank , Syfrets Trust and a few others. I used to sell my self bankrupt on Unit Trust as I believed, the lower cost associated with it will proof to be the better investment over the long run. However I was totally mistaken, the more costly 10 and 15 year endowments with a little bit of life cover added to it to make it compliant with the law, out performed the Old Mutual investor fund hands down! Now you would say that is not possible… Well the reason was that all the money saved in the Unit Trust was spend as soon as it made a little profit, while the endowments had a penalty motivation, that saw it last for the long term. Handsomely rewarding my clients! Clients are mostly ill disciplined savers and South Africa needs an endowment that are not being taxed to death in the fund. The two pot system is messing up retirement funds and has no place in a retirement fund. Bring back the good old endowments, but with a tax free incentive, then reward the advisers who motivates the clients to save by paying them what is due to them and you will see how people will start saving again.