“Looking for income in the current economic environment may mean taking on more risk,” says John Kinsley, managing director of Unit Trusts at Prudential.
Saving for retirement should be an obvious imperative, although most South Africans tend to leave it too late. In simple terms, everybody wants the highest return and growth to be able to maintain their lifestyle after retirement. But to manage that money after retirement can be more of a balancing act. You have to decide how much income you can withdraw, while still leaving enough in a ‘nest-egg’ to continue growing to keep pace with inflation to provide the same future income (after cost of living increases). Finding income in a low-interest rate environment is becoming increasingly difficult.
Despite rising inflation (mostly food and fuel, but in South Africa wages as well), the government is currently forced to keep the bank rate on hold at 5,5% because they need to promote economic growth and employment. According to Kinsley, “This makes life for retirees harder, as income has traditionally been provided by interest bearing products. With low interest rates and rising inflation, the typical money market fund, for example, is unattractive because after tax and inflation, cash gives a negative real return.”
Preserving a nest egg
Kinsley explains that there are two points to understand when you try to preserve your capital nest egg – what can be controlled and what cannot be controlled.
“You cannot control market growth or market declines, and neither can investment managers. But you can control your income level and the investment expenses,” he explains. The key premise is that the income you draw and any investment expenses must come from the income generated by the returns of the underlying assets and not from your capital.
Once you start drawing on your capital it becomes that much harder to regain the purchasing power of the initial lump sum you invested.
“At Prudential we are realistic about managing expectations. In the current market environment, investors may have to take on some extra risk, in the form of a higher exposure to riskier assets, in order to safeguard future income flows,” Kinsley adds.