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Why a written investment plan is a good idea

By Jannie Leach, Head of Core Investments

If you have started saving or are about to start, a written investment plan can keep you on track.

If you have ever been in formal employment you would have likely belonged to a retirement fund provided by your employer or you may have taken out a personal retirement annuity. Ideally you should be contributing to some form of retirement savings vehicle throughout your career - without dipping into these savings before you retire. And, while most people know and acknowledge this – when it comes to executing a long-term savings plan it can become overwhelming. This is where a written investment plan can be invaluable.

If you have started saving for retirement or are about to start, do you know how much you will need for retirement? Secondly, do you have an investment plan to achieve this goal? These questions also can be extended to other savings goals, like saving for a home or for a child’s education.

Start at the beginning: How much do you need to save?

The table below provides a simple guideline for how much you need to have saved up at the various stages of your working career.

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Conceptualise the road ahead - what are some of the potential pitfalls?

During the early stages of your career it may be tough to achieve these goals. However, instead of simply giving up, you can steadily increase your retirement contribution as your salary increases and you reap greater benefits from the tax deduction on retirement contributions[1]. Numerous surveys[2] have shown that investors struggle with long-term savings goals such as saving for retirement. People are generally better at saving for shorter term goals but still struggle with how they should go about achieving these goals given the myriad of different investment and savings options available in the market. The latest fads such as Bitcoin and other hot investment tips makes it even more difficult to put a sound investment plan in place.

It is therefore helpful to know how much you need to save and to put an investment plan in place on how to achieve these goals.

Understanding the Investment Policy Statement

If you belong to a pension fund provided by your employer then the investment portfolios made available to you would follow the Investment Policy Statement (IPS) of the specific pension fund.

This IPS is essentially the investment plan for the whole pension fund which includes members (employees) of all working ages and defines the investment framework for achieving their future retirement needs. The IPS also defines the governance framework of the investment plan, for example the setting an appropriate asset allocation, monitoring the investment plan, risk management and reporting. It furthermore assigns accountabilities to all the different parties and entities involved in implementing the investment plan.

One of the most important functions of the IPS is to provide objective guidance and course of action during times of market turmoil when investors’ emotions may drive them to not act prudently. It is therefore the document that can always be referred when the investor is uncertain so that the investment strategy can stay on course.

Make it real - develop your own IPS

You should ideally have your own individual investment plan which includes all your different saving goals and just like an IPS defines how you will achieve these goals and whom you will give the responsibilities for the different roles in this plan. If you have a financial advisor, most of this information should be included in your record of advice, but ideally, you should ask your advisor to provide you with a layman’s version of their IPS which covers the investment framework employed in your investment plan. If you don’t have a financial advisor you may want to consider a virtual advisor such as the Nedgroup Investments Extraordinary Life™ Virtual Advisor Platform which will be launched over the next few months and will provide such an investment plan.

The following example will be used to illustrate what the IPS should potentially look like.

Example: Saving for retirement[3]

Let us consider Mark who started working at the age of 25 earning R250k per year with annual increases of 5.5%. Over the span of his career he was promoted and received a 15% increase after 5 and 10 years, 10% after 15 and 20 years and 7.5% after 25 years of service. At retirement 40 years later, he was earning R 2.7 million.

Setting an investment plan

1. Investment objective

Mark will require at least 16 times his final salary at retirement which is around R43m. Because he needs more liquidity in his younger years to buy a car, travel, buy a house and save for his children’s education, he increases his retirement contribution as his marginal tax rate increases throughout his career. He therefore contributes:

  • 12.5% for 4 years (i.e. until 31% tax bracket reached)
  • 15% for 4 years (i.e. until 36% tax bracket reached)
  • 17.5% for 4 years (i.e. until 39% tax bracket reached)
  • 20% for 4 years (i.e. until 41% tax bracket reached)
  • 23.5% for 13 years (i.e. until 45% tax bracket reached)
  • Maximum allowed for the last 11 years

2. Investment strategy

In order to retire with at least 16 times his final salary Mark will require an average annual return on his retirement savings of around Inflation + 5% (10.5%) over the 40 year period. A traditional balanced such as the Nedgroup Investments Core Diversified Fund targets inflation + 5 % over the long term and so would be well suited to achieve Mark’s investment Goal.

Alternatively, if he is comfortable with taking slightly more risk, Mark can opt for a more aggressive balanced fund such as the Nedgroup Investments Core Accelerated Fund which targets inflation + 6%. Mark may also consider using a life-stage strategy where he is invested in an aggressive balanced fund until about 8 years prior to retirement and is then systematically moved into a conservative balanced fund so that he doesn’t take on excessive risk just prior to retirement.

3. Ongoing monitoring of the strategy

Mark periodically monitors whether he is on track by simply comparing his retirement fund savings to his current salary, e.g. retirement savings is 1.4 times his current salary. He also monitors whether his portfolio is delivering the target return over meaningful periods. A traditional balanced typically achieve it inflation + 5 % target over 5 years and longer. Over shorter periods it may be much lower or higher depending on recent market performance.

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If Mark is behind his target he may opt to top up his retirement savings by increasing his retirement fund contribution rate or investing in a Retirement Annuity or Tax Free Investment.

Result of implementing the investment plan successfully

Assuming mark followed his investment plan as it is stated; he would comfortably achieve his retirement target of 16 times his final salary as illustrated. In fact, he could even exceed it by a multiple of 4 which would allow his retirement saving to comfortably last more than 20 years.

 

[1] See “A tax-efficient strategy to enhance your savings during your career”, Newsletter Q1 2017.

[2] For example the Sanlam Benchmark survey 2017.

[3] Disclaimer: This example is for illustrative purposes only and does not constitute advice. 

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