Your top 10 retirement savings mistakes (part 1)

What kind of retirement is realistic for you, and how much do you need to save to make it a reality? Far too few South Africans actually ask themselves these questions. 

If you’re going to draw an income from your investments to maintain your current lifestyle (and you don’t have any other income options), there are a couple of rules of thumb you can apply: multiply your final annual salary by 15, or consider that for every R1m you have invested, the upper limit of a sustainable pre-tax monthly income drawdown is only around R5000.

Either way, being disciplined about retirement saving is key, and you’ll want to understand what not to do in order to take the stress out of your golden years.   

Paying high fees (and letting compounding work against you)

Do you know how much you are paying away in investment fees every year? And how much this adds up to over thirty or forty years, after you include the additional return you could have earned on those savings? Consider the graph below, and then apply that to your own situation by using our EAC calculator.

The truth is that paying high fees greatly diminishes the likelihood that you will achieve your retirement goal. In our example above, we used a net real investment return of 4% pa. Remember that we are talking about the real return, after inflation. That is the return that actually grows your wealth. 

There is always a cost to investing, but you need to keep it as low as possible. Why? Because the impact compounds against you. In reality, every 1 percentage point in fees reduces your real investment return by around 20%. Alternatively, every 1% in fees you save improves your long-term savings outcome by around 30%!

The bottom line: know your fees. Paying a fee of 3% per year over 40 years will almost halve the real value (purchasing power) of your pension. And it will quite possibly ruin your retirement.

Saving too little 

Not a difficult concept to understand – you can’t save like a pauper and then expect to live like a prince in retirement. Easier said than done, however. 

The number one reason most people miss their retirement goal is because they don’t save enough. Empirically, the amount you contribute to your savings plan is the largest single factor that determines your savings outcome. But that can be hard while supporting a family, with unexpected expenses cropping up every month and a host of other financial obligations. 

Strive to save at least 15% (before fees) of the income you wish to replace in retirement. This is especially important for private sector employees. Compare the mandated contributions to the Government Employee Pension Fund: 7.5% from the employee and another 13% from the employer. The reality is that the majority of private sector employees underfund their retirement.

Starting too late (and not letting compounding work for you)

Few people in their twenties worry about retirement. And that’s the reason they get to worry about it for the rest of their lives.

The key here is understanding that contributions are only one source of your future retirement income; the other is the net investment return you earn on your contributions. The sooner you contribute to your retirement fund, the longer your money works for you and the more the net investment return contributes to your pension.

Initially, returns add only a little to your total investment. But then compounding (earning a return on your return) kicks in. Compounding acts like a snowball rolling down a mountain: it keeps growing and picking up momentum. Ultimately, the compounded investment return totally overwhelms your contributions. In numbers, say you earn a total real (after-inflation) annual return of 4% pa (net of fees) on your constant annual contribution. After 10 years, returns equal roughly 32% of your total contributions, after 20 years 74%, after 30 years 132% and after 40 years 217%.

As you can see, the big kicker to your pension comes in the last ten years of this 40-year example. So, if a 40-year time horizon seems impractical for you right now, then it might be wise to start thinking about saving even more immediately, as well as considering other sources of income during your retirement.  

Not preserving pension or provident fund savings

Not preserving pension or provident fund retirement savings when changing employers is very popular in South Africa. Between 70% and 80% of fund members have at some point not preserved when changing jobs - sometimes because of pressing financial concerns, but often, because buying a new car was more important. 

Not preserving has the same effect as starting late. When you change jobs and cash in your pension, you not only lose your accumulated savings, but also the return you would have earned on those savings for the rest of your working life. Over twenty or thirty years, that makes for a very expensive car (or whatever else it was you bought with that money).

Holding an overly-conservative asset mix

Investing too conservatively is one of the riskiest things you can do with your retirement savings. Why? Because it increases the probability that you won’t make ends meet in retirement.

In our everyday lives, most of us are risk-averse. And this bleeds into our financial decisions. We ‘play it safe’ with our money by putting it in a medium-risk portfolio, which ultimately means moderate (i.e. too low) investment returns.

Investment risk refers to the probability that the actual investment outcome differs from the expected outcome. As the investment return from shares is volatile, this probability is high – but only in the short-term. Share markets have been known to double or halve within a 12-month period. But that volatility is negated if you have a 40-year time horizon. Historically, as the investment term has lengthened, so share returns have become less volatile and more predictable. And they have been well above those of bonds and cash.

So let your time horizon guide your investment risk. If you are young, you can afford to ride out short-term volatility and invest in a high risk (high equity) portfolio, with the reasonable expectation that this asset class will deliver the highest return over the long term. As you come to the end of this term, increase your allocation to lower return assets such as bonds and cash, to preserve what you have saved.