A recent analysis by Old Mutual Corporate highlights the impact of sequence-of-returns risk on retirement outcomes in South Africa. Two savers who contributed R10,000 monthly towards retirement from April 2007, with a 4.5% annual increase, and made no early withdrawals, ended up with significantly different retirement incomes. Despite having similar investment goals and returns, one saver had 27% more money than the other by March 2020, resulting in a substantial disparity in their retirement incomes.
The two savers' funds targeted returns of at least Consumer Price Index (CPI) plus 5% per annum, a standard benchmark for retirement planning. However, their retirement dates coincided with the Covid-19 pandemic, which led to a market crash. This event further exacerbated the disparity in their retirement incomes. One retiree earned R10,000 per month from a life annuity, while the other received R7,300, resulting in a nearly 30% reduction in their standard of living.
Marvin Nair, investment solutions executive at Old Mutual Corporate, discussed this issue at the Institute of Retirement Funds Africa (Irfa) conference. He emphasized that retirement dates are largely determined by birthdates, which can have a significant impact on retirement outcomes. Nair used a 13-year time horizon for his analysis, coinciding with the launch of Old Mutual's Absolute Growth Portfolios (AGP) Smooth flagship product in April 2007.
The analysis compared the performance of Old Mutual's AGP Smooth product with the median fund return from The Alexforbes Global Large Manager Watch Survey 'Best Investment View'. The results demonstrate the significance of sequence-of-returns risk, which can have lasting consequences for retirees. Members invested in market-linked balanced funds can suffer substantial losses when markets fall during retirement.
A second example illustrates the impact of sequence-of-returns risk over a longer period. Two investors, each starting with R5 million in 2007, used a living annuity with a monthly withdrawal of R30,000, increasing by 4.5% per annum. After 19 years, the investor in the risk-managed solution had R11.5 million remaining, compared to R3.7 million for the investor in the non-risk-managed portfolio, a difference of over 200%.
Nair noted that the investor with R3.7 million risks depleting their funds during their lifetime, which is a concerning outcome. In contrast, a smoothed bonus product can help reduce the impact of market fluctuations. This type of product allows the insurer to invest in a mix of underlying assets, declaring periodic bonuses based on a reserve, rather than passing through raw market returns.
The goal of a smoothed bonus product is to provide a more stable income stream for retirees. By holding back some returns during strong markets and using them to support bonuses during weaker periods, the product aims to reduce the volatility associated with traditional balanced funds. This approach can help mitigate sequence-of-returns risk and provide a more predictable retirement income.
Key points
- Sequence-of-returns risk can significantly impact retirement outcomes in South Africa.
- A 27% disparity in retirement savings can result in a nearly 30% reduction in standard of living.
- Smoothed bonus products can help reduce the impact of market fluctuations on retirement income.
