Many investors (and their advisors) swear by the ‘life stage’ model of financial planning. Here’s why this is a heresy that should be discarded.
Many financial advisors swear by the ‘life stage’ model, and a number of employer pension funds provide their members with a choice of portfolios that reflect various appetites for risk. The theory behind this model is that young investors with many years to go to retirement should invest in more aggressive instruments (such as equities), and as they get closer to the ‘normal retirement age’ (usually 65), they should progressively move an increasing percentage of their retirement portfolio into more conservative instruments (such as bonds or cash).
Nonsense!
This is why I believe that a ‘life stage’ model – especially that of the ‘one size fits all’ variety – holds little merit in the real world. For starters, it assumes that we all follow a linear path from around age 25 to 65, with 25 representing graduation from university and completion of one’s practical training (where applicable), while 65 is when the working world gives you the ‘left foot of dis-fellowship’ and you end up rolling, kicking and screaming, into retirement.
The typical life-stage model operates on a similar premise to the following:
- Age 25-40: You are starting out in life, and still have many years to go until you reach retirement age. Your retirement portfolio should therefore be invested as aggressively as possible (i.e. equities), since you have more than enough time to ride out the ‘swings and roundabouts’ of the markets. (The fact that Regulation 28 does not allow retirement funds to invest quite as aggressively as the pundits would suggest is often overlooked!)
- Age 40-55: You are getting older, and therefore cannot afford to take quite as much risk with your retirement capital. Many proponents of the life-stage model suggest moving an increasing portion of your retirement capital into ‘smoothed-bonus’ funds (where returns are ‘smoothed’ over multiple years, which entails taking away some of the ‘excess’ returns in good years and giving some of them back in bad years).
- Age 55-65: With only 10 years to go until retirement, some suggest that since you will be reliant on a steady income stream where you cannot afford to take any capital risks, you should start moving out of the smoothed bonus portfolio into fixed-interest investments (such as bonds).
This is why I believe that a ‘life stage’ model – especially that of the ‘one size fits all’ variety – holds little merit in the real world.
However, such a model does not take any of the following possibilities into account:
- Living at a level of spending that is way below one’s income, and saving the rest. I’m not talking about the standard insurance industry advice of saving around 15% of one’s monthly income. I’m talking about levels of saving ranging from 30-70% of one’s income. Not possible? There was a stage in our lives where my family and I were saving approximately 40% of our income (while still enjoying a reasonable middle-class lifestyle that the majority of the world’s population would consider obscenely luxurious) – then we moved to a country where the price of an average house is among the most expensive in the world! That said, if we include the capital portion of our monthly mortgage repayment, we’re currently sitting on around 27% and aim to shovel any future salary increases into savings so as to cross the 30% threshold in the next couple of years. Also, while we don’t indulge in (quite frankly wasteful) luxuries such as Breitling watches, fancy German vehicles (although I did recently splurge on a second-hand Jag…), or copious quantities of Johnnie Walker Blue Label, our lifestyle is hardly what one would call any great hardship.
- Having more than one source of retirement income. Relying solely one one’s occupational retirement fund for one’s entire post-retirement financial needs is insanity! Doing so means that you are forced to retire from the fund in question when you retire from employment (although National Treasury’s proposed retirement reform programme includes the possibility of allowing people to defer retiring from their fund, irrespective of the date on which they have retired from their employer). Having more than one investment (such as property, unit trusts, exchange-traded funds, savings accounts, retirement annuity funds, etc.) not only provides for diversification, but also allows one to access each fund at different times as one’s needs dictate.
- Living longer. In the late 19th century, Prussian chancellor Otto von Bismarck introduced a form of social security for retiring civil servants. However, Bismarck cleverly set the age at which one would become entitled to pension benefits as age 65, knowing full well that the average life expectancy of civil servants at that time was 62! Nowadays, thanks to modern medicine and a growing awareness of healthier lifestyles, we are living longer. Quality of life at advanced age is improving – my mother at age 80 is still going strong, while I recently visited a woman who will have turned 100 by the time you read this and is not only as sharp as a tack, but (other than her one leg that is starting to cause her a spot of bother), has very little in the way of physical ailments.
- Retiring earlier. One of the likely reasons that you are reading this website is because you don’t plan to hang around working until you reach the age of 65 and receive the proverbial gold watch (do employers still give these out nowadays?). With some industrial-grade saving coupled with a no-waste lifestyle, the ordinary person can retire / become financially independent a lot earlier than the norm. This aspect will be covered extensively in future articles, but suffice to say that if you were to save two-thirds of your income (i.e. twice your spending) each year, it would theoretically be possible (at a real return of 4% per annum) to be retired in 13 years. For the average graduate professional, this could mean being financially independent at the same age that Lucy Jordan “realised that she would never ride in a sports car through Paris…” (For those younger readers who have absolutely no idea what I’m talking about, this happened “at the age of 37”). Trust me – if you’ve called it a day before you turn 40, you still potentially have a further 50 years to live, so if you’re going to shove your entire retirement fund into bonds (as a typical life-stage model would suggest), you won’t achieve a real return of 4% per annum, and will therefore run out of money…
- Choosing to continue working. After nearly 28 years of marriage, my patient and long-suffering wife has promised that she would never divorce me … but murder has not been ruled out as an alternative! My life expectancy would certainly be curtailed if I were to stop work at 65 and sit at home picking my nose (especially given that I don’t get this whole golf thing … hours and hours of televised sky, if you ask me!). Since I don’t do boredom, I will probably continue to work until the day I drop dead. Although I am now living in a country where a set ‘retirement age’ is illegal, most people tend to retire when they reach the age where they become entitled to their state pension. Me? I’ll probably work until I drop dead – and wouldn’t have it any other way. I may cut back on the hours spent in my day job, but there’s the magazine business, the bits of accounting and tax work that I do and will be able to continue with post-retirement, not to mention lecturing, writing, and a myriad other things with which I could keep myself out of mischief. Critically, whatever I am able to earn from other pursuits post-retirement means less that I have to draw from my pension. [Note that I’m not talking about working because I foresee that I will run out of money, but because I find meaning in keeping busy. If I had a million gazillion rand in the bank, I would probably still pitch up at the office most mornings. Does anyone honestly believe that the likes of Bill Gates, Richard Branson, and Warren Buffet have to work?]
By this stage I have probably been removed from the Christmas card list of every investment guru out there, and this article may well have raised more questions than answers. In future articles I will expand on many of the points raised here, and hopefully begin to answer some of those questions that come to mind.
However, suffice to say at this stage that building up retirement capital that is sufficient to live on is not rocket-science. All you need to do is:
- Eliminate waste from your budget. Practical tips will be forthcoming in future articles, but look at things like eliminating unnecessary driving by planning your trips, switching off unnecessary lights (why should you fund the Eskom bosses’ bonuses?!), and having a good, hard look at your short-term insurance premiums.
- Save as much as you possibly can. I’m talking about a significant portion of your income – at least half, and preferably two-thirds (I still have some way to go, but once I’ve killed the mortgage, watch out!). If you have already got yourself locked into a lifestyle of debt or excess spending, start with something while you attack the debt and waste. The cash flow that is released by killing your debt and declaring war on frivolous spending must be shovelled into savings – as should the lion’s share of any future increases in income.
- Invest for the best possible return. Over the longer term, that means equities. Don’t worry if you don’t know anything about the stock market at this stage – a healthy monthly debit order into index-tracker funds such as Satrix Top 40 or Satrix DIVI will put you ahead of at least two-thirds of the unit trust fund manages out there. As you become more familiar with equity markets, you can look at other possibilities as well.
- Be disciplined. Just as your body needs a regular intake of food and water to survive, your retirement capital also needs a regular dollop of investment funds if you are to have any hope of achieving your goals. Everyone is different, but I prefer monthly debit orders – that way, my investments become bills rather than something discretionary, which makes it more likely for me to commit to the programme.
