What levels of real growth are needed for a comfortable retirement outcome? Are retirement funds investing aggressively enough to achieve this? Barend Ritter, Portfolio Manager at Sanlam Investments, takes a stand and makes a case for equities.
In order to secure a comfortable retirement, real returns of between 3½ and 4½ percent of pre-retirement savings are needed. This implies that you need an equity exposure of more than 60% (up to 75%) in a typical balanced fund. This should give you sufficient returns over your working life, starting at age 30 and ending up at age 60, up to 75 years of age.
Contrary to this, however, results from the Benchmark Survey done by Sanlam Employee Benefits show that members in retirement funds are not investing aggressively enough. Of the funds surveyed, only 40% of funds said that they do offer members an aggressive investment option in a typical balanced fund. Of those funds, only a further 30% of these members were actually invested in these aggressive options.
Overall, this implies that a meagre 12% of members who participated in the survey were invested in aggressive options. And that is clearly not enough!
The role of behavioural finance (specifically ‘loss aversion’) is critical here, particularly the aversion to investing in equities that we see with retirement funds. Loss aversion is simply the human instinct to avoid losses, and we engage in behaviour that will ensure this. This is no different with investing.
As humans, we are programmed to avoid pain (fear) and prevent losses, because we experience the pain of loss twice as badly as the joy of gain. In our need to avoid pain, we invest too cautiously in equities and when a macro event takes place that leads to market volatility, we see the losses in the market and panic. Human instinct takes over and we tend to sell because we want to prevent further losses. Unfortunately, in doing this, we lock in and actualise those losses. Ironically, we bring about the very pain/loss we sought so hard to avoid.
Key takeout: Loss aversion (selling during market downturns) destroys value.
So what does it take for the markets to recover in real terms after a big slump? Interestingly, history has shown us consistently that on average it only takes four years for the equity markets to recover. If you consider a 20-year career and membership in a fund, this four-year period is not considered significant and certainly doesn’t warrant the loss-aversive selling behaviour described above.