If you do not want to erode capital in retirement your investment return must provide for both income and costs after inflation. If you’re drawing 5% income and the underlying costs are 2.5% then your investment needs to earn 7.5% above inflation to maintain the capital in real terms (13.5% nominal return assuming inflation of 6%).
The lucky kids then inherit an investment, which has retained its buying power after inflation. As a firm supporter of the SKI club (Spend Kids Inheritance) I am not quite sure why anyone would worry about this. Especially if you consider the increase in risk budget required to provide inflation growth for both income and capital.
The historical average real return for the JSE has been 8% versus only 2.5% from cash. So, in order to achieve a 7.5% real (above inflation) return a portfolio needs a high weighting in equities. Most retirees are not comfortable with the increase in volatility (risk) associated with an overweight equity portfolio, which is why many retirement portfolios are underweight equities.
As a retiree you have two choices, take on higher risk or be comfortable eroding your capital in retirement. Your advisor needs to ensure you have optimal growth (risk) assets to achieve your objective. Many retirees face the risk of running out of money owing to insufficient exposure to growth assets.
Example: Retirement Capital R 6 million with an income requirement of R 25 000 pm.
Illustration 1: Moderate risk portfolio targeting a real rate of return of 3% after costs results in a real capital amount of R 1.6 mil after 25 years.
Illustration 2: Moderately aggressive portfolio targeting a real rate of return of 5% after costs results in real capital of R 5.4 mil after 25 years.
Discuss your objectives and personal risk budget with a certified financial planner (CFP®) to ensure your portfolio is capable of providing for your objectives via an optimal exposure to growth (risk) assets.
Mcomm, CFP®, HdipTax
T. 021-851 3746