Getting an early start is crucial if you want to achieve a comfortable retirement. Adriaan Pask, Chief Investment Officer at PSG Wealth shares nine rules of thumb for young investors who want to secure a strong financial future.
Rule 1: Plan to reach your 100th birthday
Many studies have found that advances in medicine, technology and overall quality of life have resulted in the average person’s lifespan increasing by about three years for every ten years that pass. By the time a person turns 85, they will therefore require additional savings to survive until the age of 105.
However, the current pension system and retirement age in South Africa means that people tend to have less time to save enough for a longer retirement. The World Economic Forum expects a massive shortfall (US$80 trillion) in retirement funding among retirees globally by 2025 because many are underestimating how long they will live and how much money they will really need in retirement.
Rule 2: Consider inflation
For young investors, protecting your savings against inflation is crucial. Assuming South African long-term inflation averages about 6% per annum, you in essence start every year with minus 6% and need to ensure that you invest in such a way that you can recover that 6% and then grow the real value of your savings on top of that. For example, if a balanced portfolio offers a return of 11% per year, the real growth only equates to about 5% a year.
Rule 3: Start early
When you do not add to or grow your savings, your required savings rate doubles every decade. A person who retires at age 60, has a life expectancy of 85 years, and has a required real return of 5% (as the previous point mentions) should save 12.5% from the age of 20, but that rate roughly doubles every ten years.
The longer you delay, the steeper the climb. In the words of H. Jackson Brown Jr., “The best preparation for tomorrow is doing your best today.” Unfortunately, many people wait until their 30s or 40s before they start thinking of their financial future. Young investors still have time on their side, and the opportunity to start early.
Rule 4: Know where to get ‘bang for your buck’
Investments need to have exposure to growth assets like equities in order to protect against inflation. Equities have historically delivered better returns than other asset classes. This is because the impact of short-term market downturns weakens when staying invested for ten years or more. Data also shows that equities have offered the best real returns over longer periods.
Rule 5: Being overly conservative can be a risky strategy
Not all asset classes are engineered to protect savings against inflation. For example, cash is a great way to cater for short-term income needs but provides the weakest protection against inflation.
A portfolio that consists solely of cash is almost guaranteed to underperform inflation after fees and taxes. As a stable asset class, it may provide short-term comfort, but over the long term, the opportunity cost is significant.
Rule 6: Compound interest is your greatest ally
Over the short term it may not seem like the difference between 7, 8, 11 or 15 percent is all that much, but these differences grow and compound over time. For example, a R100 cash investment that grows at 7% would grow to R387 over a 20-year period, whereas an equity investment growing at 15% would be worth R1 637.
Rule 7: Risks reduce over time
Although equities can be volatile over the short term, they move closer and closer to their long-term returns as time passes. Thus, the returns can vary greatly over a short-term period, but the range of possible outcomes reduces as time passes. Young investors have the best chance to use time as protection against uncertain outcomes.
Rule 8: The plan is the map, and the map is sacred
Planning and preparation are integral parts of wealth creation. When markets turn volatile (as they often do), it’s important to recognise that these events have already been factored into the plans a financial adviser has prepared for you.
We view these events as a natural part of the journey, a proverbial hump in the road. As long as you stick to the map, you won’t get lost. Have you ever tried to outsmart Google Maps? It rarely ends well!
Rule 9: Take advice
Investors who heed the advice of professional financial planners have a better chance of reaching their investment goals.
Research from Morningstar, entitled ‘Alpha, Beta and now Gamma’ , argues that investors can generate better returns by having a sound investment plan and sticking to it. The research concludes that the retirement income for a hypothetical investor would be nearly 23% higher if they made use of a financial adviser.
This post was based on a press release issued on behalf of PSG Wealth, which provides a comprehensive wealth-management offering designed to meet the needs of individuals, families, and businesses.