Staying invested during times of market turbulence rather than switching to cash could mean the difference between R1.7 million and R10 million in retirement savings.
Ninety One product specialist Marc Lindley recently explained that generating returns ahead of inflation is crucial for sustaining income in retirement.
“However, it is widely accepted that returns that exceed inflation cannot be achieved without taking risk,” he said.
“This discipline of holding the right proportion of assets to balance risk and return is easy to do when markets are rising; however, it can quickly be forgotten by investors during a crisis.”
Lindley’s comments come in light of United States President Donald Trump’s ‘Liberation Day’, which wreaked havoc on markets and resulted in equity losses in the trillions of dollars.
The JSE All-Share Index shed 8.48% in the two days following Trump’s announcement on Wednesday, 2 April, while the rand fell to record lows.
He explained that, while drawdowns can be severe, inflexion points in the market can be equally rapid and pronounced.
Uncertainty about the duration of the crisis and concerns over further market declines are likely to cause many investors to consider switching into ‘safer’ assets.
However, Lindley pointed out that, historically, investors have risked a permanent loss of capital by switching to cash. He used the 2008 global financial crisis and the Covid-19 pandemic in 2020 as examples.
“It was not surprising that in such uncharted territory, industry views around the potential shape of the recovery varied, and concerns around another dip were rife,” he said.
“Despite these concerns, the market recovered most of its losses in approximately 3 months. Those on the sidelines missed out.”
Lindley said this is something retirees should be particularly aware of, as those in living annuities face an extra challenge during these times.
He explained that these retirees’ requirements for income force them to make regular withdrawals, even at times when the capital value of their investments has been significantly reduced.
“Many feel that selling into weakness to fund their monthly annuity will have a negative impact on the sustainability of their income and therefore switch into cash to preserve the value of their nest egg,” he said.
“While this instinct to try and avoid further capital erosion is understandable, in practice this behaviour often has the opposite effect to what was intended.”
He emphasised that simply preserving capital is not enough, because inflation erodes its value over time, and this effect is magnified when an investor also draws an income.
Five scenarios
To illustrate his point, Lindley looked at a scenario where a client retired at the beginning of 2007, the year in which the global financial crisis began.
This hypothetical client invested R5 million into a living annuity, drawing a 5% income with the rand value of the income escalating by inflation each year.
Lindley then considered five scenarios using the Ninety One Opportunity Fund as the underlying investment:
- Scenario one – The client remained invested in the fund for the entire period.
- Scenario two – The client switched out of the fund and into cash and remained there.
- Scenario three – The client switched out of the fund into cash and tried to time the market by switching back into the fund a year later.
- Scenario four – The client held their nerve during the global financial crisis and remained invested in the fund, but during the Covid-19 pandemic, they switched to cash for a year before switching back into the fund
- Scenario five – The client held their nerve during the global financial crisis but switched into cash during the Covid-19 pandemic and remained there.
Then, Lindley matched the rand value of the income drawn in all five scenarios and found that the difference in outcome is astounding:
- Scenario one would have resulted in a final portfolio value of nearly R10 million, and the last income drawn would equate to 6.04% when expressed as a percentage of capital.
- Scenario two would have resulted in an end value of just R1.7 million, and the income draw would have breached 17.5% in 2022. This means the income produced would no longer be sufficient to meet the investor’s future income needs.
- Scenario three would have meant that the annuitant gave up more than 50% of the portfolio’s capital value than if the choice had been to remain invested. This would have resulted in an end value of only R4.8 million with an income draw of 12.28% of the capital value.
- Scenario four would have resulted in a value of R8.6 million, leaving the client with 13% less capital than if they had remained invested throughout. The final income draw increases to 6.88%.
- Scenario five resulted in a value of R7.3 million, over 25% lower than remaining invested, and a dramatic increase in the income draw to 8.2%.
“The strategy of remaining invested delivered by far the best outcome for retirees,” Lindley said.
“Importantly, the capital value continued to appreciate, but of greater significance is that the percentage income drawn remained within acceptable parameters over the 18-year time horizon.”
The graph below, courtesy of Ninety One, shows the divergence in outcomes from Lindley’s five different scenarios.
