When you are young, you may be tempted to put retirement savings on the back burner on the assumption that you still have many decades to save before you retire.
There is just one big problem with this rationale – you are working against your greatest investment growth asset: time. When it comes to saving for your financial future, it really is a case of the sooner you start, the more room you give yourself to achieve your retirement goals, and the less pressure you will feel as you get older.
Starting to save from your first day of work teaches you to be consistent when saving for retirement. If you start by putting away R500 per month at your first job, and remember to increase your contribution as your salary grows, saving will be instilled as a healthy habit that will serve you well in later years.
You should strive to save between 10% and 15% of your salary. This may sound daunting but if you are fortunate enough to have an employer who contributes, each of you need only contribute 5%.
All too frequently though, young people starting their first job have no idea what their retirement saving goals should be – or how to achieve them. “Where do I start?” is a common question. Fiirst-time salary earners should ask themselves the following five questions:
Should I choose a conservative or high-risk investment?In theory, the higher the risk, the more return you should receive on your investment. Conversely, the lower the risk, the lower your return. The risk you choose for your investment is therefore fundamental to the returns you achieve over the years. No successful savings plan can be discussed without mention of the risk involved.
Investing conservatively means protecting your nest egg against the chance of any loss, but it also means ensuring that none of the potential losses will be overwhelming. The downside is potentially losing large interest gains if the investment is too conservative. When you are young, you can afford to take bigger risks, as the luxury of time gives you more room for error.
Two main factors should be taken into account when considering your risk tolerance: the time horizon and the funds available. When you start saving towards financial stability too late, investing your money in higher-risk stocks is not the best strategy, as you have less time to overcome volatility or price fluctuations. With more time, investors have more room to recoup potential losses and are consequently more tolerant of higher risk – which means more returns.
Is an RA, pension fund or provident fund right for me?To make this important decision, it’s critical to understand the differences between the various types of funds. Before the T-Day legislation proposals, the big difference between pension funds and provident funds was that a provident fund allowed you to withdraw your full benefit when you retire, while with a pension fund, you needed to buy an annuity (a monthly income). The new legislation stipulates that all pensioners are now required to buy an annuity to ensure that their funds last longer and can be sustained over the long term.
Another point to remember is that only an employer can claim a tax benefit from provident fund contributions, while with a pension fund, both the employer (up to 20%) and the employee (up to 7.5%) can claim their contributions for tax purposes. Provident funds are therefore more suited to lower income earners who don’t benefit from the tax deduction.
A retirement annuity (RA) is a good option when your employer doesn’t make contributions to your retirement or if you want to save more for your retirement. With this plan you are able to set the date that your annuity will mature (pay out), which in most cases is between 55 and 70 years.
Who should manage my money?For young savers who have a keen interest in investments, there are three questions you need to answer before consulting a financial adviser:
• Do you have a solid knowledge of investments?
• Do you enjoy reading up on investments and doing research?
• Do you have the investment expertise and knowledge when it comes to retirement planning (and do you have time to monitor and evaluate the options available in order to make necessary changes to your portfolio)?
If you’ve answered ‘yes’ to these questions, you can seek expert advice from an adviser to get started. It is always advisable to start with a financial adviser to learn best practice before taking the plunge on your own.
What is the best way of finding an adviser to suit your individual needs? Start by speaking to family members or friends whose finances are being managed successfully – they should be able to recommend someone suitable. Advisers are there to help you make informed financial decisions. You should meet with your adviser at least once or twice a year to review your financial portfolio and ensure your retirement savings plan is still on track.
When should I consider increasing my contributions?It is typical to contribute a small percentage of your salary to your retirement savings when you are young and increase this amount as your salary grows. A retirement calculator will help you see how your contributions need to grow to keep ahead of inflation.
Remember that if you are young and can’t afford large contributions, consider how the power of compound interest will influence your savings or nest egg. If you save R1000 per month from the age of 20 to 30, and then leave the investment to grow at an annual rate of 12% until you turn 60, your investment would have grown to over R6.7 million. This amount is much higher than the R3.1 million you would have if you saved R1000 from the age of 30 to 60. This example clearly illustrates the power of compound interest.
How much should I pay my adviser?You should never pay your adviser more than 3% of annual value of the assets under management, and should negotiate an acceptable fee of 1.5%. Since the amount deducted for adviser fees will impact your eventual retirement package, it is imperative to research and understand what fees are being charged for what services.
In conclusion, you need to make it a habit to educate yourself on all aspects of financial decision-making, as this knowledge will serve you in good stead throughout your life.
Understanding the impact of your decisions will help you to plan for a more secure financial future. From a retirement planning perspective, saving is all about generating an income for yourself in your later years. It is never too late, but leaving retirement saving to later in life can prove to be a costly error – which can easily be avoided through entrenching healthy savings habits from an early age.
Mayuri Reddy is the market strategist at Sanlam Employee Benefits.