“Money doesn’t create happiness. It can provide you with temporary happiness, but lasting happiness comes from what you do with your life,” Craig Torr says.
Torr, a Certified Financial Planner professional, addressed the April meetings of the acsis/Personal Finance Financial Planning Club.
As we age, we tend to want to do things rather than to buy things, he says. Financial planning is about living a great life and not just about making a good living.
You choose the life you want to live, and your choices affect how you live at every stage of life, he says.
Between the ages of 25 and 34, you typically find yourself in “the lean years” – paying off a mortgage bond and married with children, Torr says.
Between 35 and 44, you are in “survival” – paying insurance and school fees, as well as your mortgage bond, he says.
From 44 to 54, you are in “middle age”, with your children having left home – and you now have a little surplus income, Torr says.
Between 55 and 64 – “pre-retirement” – you are looking carefully at your investments, he says. And from 65, you are in retirement, hopefully reaping the rewards of your labour and monitoring your investments, Torr says.
Scenario planning is key to financial planning from the cradle to the grave, Torr says. It is possible to plan for all of life’s eventualities, including the unforeseeable.
The foreseeable includes buying a house or starting a family: children will fall sick and they have to be educated, so it is imperative to have medical cover and to save for their education, he says.
But planning for untimely death, disability or contracting a dread disease calls for more complex planning, Torr says. Here you need to consider how much life cover, health insurance gap cover and income protection will be enough.
To do this – to cover your risks and protect your assets sufficiently – you need to understand your assets. Torr says assets fall broadly into four categories:
* Business assets. These are not just the tools of your trade, but essentially your intellectual property and the skills you use to earn an income. These assets fund your lifestyle and lifetime assets.
* Lifestyle assets. These include your home, motor vehicle, holidays and “toys” (such as your bicycle or camera equipment).
* Lifetime assets. These are your investments – including shares, retirement funds, unit trusts or an investment property. These assets generate an income for you and are used to fund your retirement.
* Surplus assets. These are assets that you do not need to maintain your lifestyle – what you may have inherited or plan to bequeath to charity.
Planning for both untimely death and eventual death is a critical aspect of your financial plan, Torr says. This is all the more important if you are married and the family is reliant on both your income and your spouse’s, he says.
Traditionally, financial planners would assess your risk – by establishing your tolerance for risk through a risk profile questionnaire – and then select asset classes accordingly, Torr says. Your investments in these asset classes would generate returns that “box you in” by determining your future lifestyle.
A new and better planning approach is to start with the post-retirement lifestyle that you want to live, Torr says.
Your chosen lifestyle will determine the investment returns that you need to achieve. The returns you need to achieve will drive the asset allocation that is required, Torr says. And your asset allocation will determine your risk profile. Some trade-off may then be required if the level of risk required is not one you can tolerate.
If you are unhappy with your retirement plan, you have only four choices, Torr says. You can:
* Delay retirement;
* Save more before retirement;
* Spend less in retirement; and
* Take more investment risk.
Torr says most retirees run out of money because they:
* Do not have a game plan. Borrowing from the popular children’s story Alice in Wonderland, Torr tells of when Alice comes to a fork in the road and asks the Cheshire cat which road she should take. “Where do you want to go?” asks the cat. “I don’t know,” answers Alice. “Then it doesn’t matter,” the cat says.
* Make bad financial decisions. Retirees who try to time the market will come unstuck, Torr says. Many investors adopt a herd mentality, going into markets at or near the top of an investment cycle and bailing out when share prices are low. In other words, Torr says, they buy at high prices and sell when prices are low.
* Underestimate how long they will live. In 1800, the life expectancy was 38; in 1900, it was 53; but in 2012, if you have lived to 65, you have a 25-percent chance of living to the age of 97, Torr says.
* Retire too early. Some of the most successful people achieved their goals after retirement age, he says. Harland Sanders – better known as Colonel Sanders, the founder of Kentucky Fried Chicken – and John Glenn, the oldest astronaut, are but two examples.
* Over-spend. People who over-spend struggle to delay gratification, Torr says.
The benefits of delayed gratification are far-reaching. Torr tells of a fascinating study by American psychologist Walter Mischel in the 1960s. He conducted an experiment with four-year-old children using marshmallows.
“The children were given a marshmallow to eat. They were told that if they could wait 20 minutes without eating the marshmallow, they could get another marshmallow. Some children waited and some did not. Researchers then followed the children into adolescence and early adulthood. The ability to wait for that second marshmallow proved to be a strong indicator of their success and happiness through school and into early adulthood,” Torr says.
CASE STUDY: STRATEGIES FOR INVESTING FOR RETIREMENT
Mr Botha is 60 and wants to retire at 62. He has substantial assets made up of compulsory and voluntary investments, Craig Torr says.
Mr Botha’s compulsory investments amount to R4 035 000 (R2 470 000 in a preservation fund, R835 000 in his provident fund and R730 000 in his retirement annuity). His voluntary investments amount to R7 120 000 (he has a property worth R1.2 million, local unit trusts worth R1 470 000 and offshore investments worth R4 450 000).
Mr Botha has monthly expenses of R32 000, and he spends R80 000 a year on local and overseas holidays. On retirement, he plans to buy himself a car for R200 000 and to spend R150 000 every 10 years to replace his wife’s car.
Torr says that if Mr Botha were to define himself as low-risk, he would invest his money at a return of inflation plus one to three percent. Based on that assumption and a retirement age of 62, Torr says, Mr Botha will run out of money at the age of 85. (Remember, he has a 25-percent chance of living to 97.)
But if Mr Botha delays his retirement to 65, his money will last him another five years, Torr says.
In a third scenario, Torr assumes Botha is not so conservative, so he invests his money at a return of inflation plus three to five percent, and he delays retirement to age 65. In this case, his money will last until he reaches 100.
Torr says different investment strategies produce different ranges of likely returns, and the higher the targeted return, the greater the range. The shorter your investment term, the higher the volatility, he says.
For example, inflation plus one to three percent has a 10.3-percent risk of a negative return in any one-year period. But if you stretch your investment term to three years, your risk of a negative return reduces to 1.4 percent, Torr says.
If you adopt a more aggressive strategy, seeking a return of inflation plus five to seven percent, your risk of a negative return is greater, Torr says. Over the short term (one year), the risk will be as high as 18 percent, but over a five-year period, your risk of a negative return reduces to two percent, he says.
A CHANGE OF MIND
As we grow older, there’s a shift in how we make decisions – and not just those relating to money, Craig Torr says.
“As we age, our decisions are governed less by the left brain and more by the right brain. The left brain is where computation, logic and analysis takes place; the right brain is where creativity, imagination and intuition is processed,” he says.
It’s interesting to note, Torr says, that Bill Gates launched the Giving Pledge in 2010, when he was 55. The Giving Pledge is a campaign to encourage the wealthiest people in the world to commit to giving most of their money to philanthropic causes. Torr says that the first 40 donors to make their pledges did so after the 2008 financial crisis – after losing a significant percentage of their wealth, emphasising that we choose how we want to live.