Embarking on the golden years of retirement brings with it the promise of relaxation and the freedom to pursue longheld passions. However, it also poses the critical challenge of ensuring your retirement savings lasts. A successful retirement is greatly influenced by careful asset allocation and withdrawal choices, which, if managed carefully, can substantially increase your chances of stable living standards. In this article, we will again use our pre- and postretirement tool based on The Big Picture from Investments Illustrated to delve into whether and in what ways the seven key variables can ensure that your nest egg not only lasts but also thrives throughout your retirement journey.
What matters most - Asset allocation or drawdown rate?
Californian financial planner William Bengen made the ‘4% rule’ famous in the 1990s. This rule states that if retirees withdraw 4% of their savings annually and increase this salary by inflation every year thereafter, their nest egg will last at least 30 years. This rule also requires retirement savings to be invested 50% in growth assets (equity and property) and 50% in income assets (bonds and cash). Even though this rule makes perfect sense, retirement is certainly not an one size fits all solution and retirees need to adjust both their asset allocation, fees and drawdown rates to achieve their own sweet spot.
In South Africa, the Association for Savings and Investment South Africa (ASISA) closely monitors the average drawdown rate of the South African living annuity industry (currently at 6.66%) and publishes various useful tools on managing retirement savings. Their table below expands the ‘4% rule’ across the various permutations of investment return targeted – which is driven by growth vs income asset allocation – and drawdown rate, to show how long your capital will likely last at each combination.
As you increase your exposure to growth assets, your expected annual return increases. A traditional multi-asset high equity fund with a ‘70% growth assets 30% income assets’ split for example will sit in between 10% and 12.5% return per year before fees over the long term, so net of fees this is likely to be somewhere between 7.5% to 11.5%.
Then at each drawdown rate, the higher your expected return, the longer you can expect your capital to last. In other words, an increased exposure to growth assets improves the longevity of your capital invested. Similarly, at each expected annual investment return, the lower your drawdown rate the longer your capital will last. The other important variable at play here is fees. You need to ensure that your annual costs stay as low as possible to keep as much of your annual investment return as possible invested.
Let's put these variables to the test
Let’s revisit our opening article’s case study, 57-year-old Bongani and assume he is currently set up for failure as per the below retirement savings plan.
The table below illustrates how his likelihood of success changes as his asset allocation and / or drawdown rate is adjusted, as well as his annual costs.
The importance of asset allocation in Rands and cents
Asset allocation remains a very powerful and critical lever in retirement and once the correct asset allocation is achieved, drawdown rate and total fees can do the rest. It is important to remember that, assuming you plan to keep your retirement savings invested, your investment horizon is still an additional 20 – 30 years in retirement. In other words, multi-asset high equity is still appropriate.
Let’s illustrate how a change in asset allocation can double your salary. Using Bongani again, we’ve kept his opening lump sum (R 10 million), annual costs (1.5% per annum), life expectancy (30 years) and likelihood of success (82%) constant and only changed his asset allocation and drawdown rate to see the impact on his monthly salary in rands and cents. As promised, and illustrated below, Bongani can double his salary from R20k per month to R40k per month by simply switching out of his income solution into a multi-asset high equity solution.
So, what matters most?
The interplay of the key variables, asset allocation and drawdown rates, while keeping annual costs as low as possible is crucial for a thriving retirement journey. By integrating these elements, rather than considering them in isolation, retirees can create a robust financial strategy that not only preserves their nest egg but also fosters its growth, ensuring a secure and prosperous retirement.
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