Inflation and volatility are the biggest threats facing people saving for retirement, Hassan Motala, a senior analyst at Oasis, says, but the desire of many savers to avoid volatility at all costs jeopardises their ability to beat inflation, which is the greater of the two risks.
Motala addressed a workshop on retirement planning hosted by the Financial Planning Institute in Cape Town recently.
Many investors cannot cope with the fact that markets rise and fall, sometimes daily or weekly, and would prefer their financial planners to put them in non-volatile assets, Motala says. Although volatility is a risk, it is a risk that diminishes the longer your time horizon. Inflation, on the other hand, is a risk that increases over time.
South Africa does seem to have moved into an environment of structurally low inflation, particularly compared with the double-digit inflation rates that prevailed in the 1980s, Motala says. Even if it is safe to assume that inflation will average six percent over the next five to 10 years, he says this rate will have a big impact on your ability to create and preserve wealth.
Motala says you should also keep in mind that South Africa has experienced a bull market across all the main asset classes over the past 10 to 15 years, but the consensus view is that returns will be much lower from now on. This will make it difficult for investments to generate inflation-beating returns, he says.
It is vital that you, as an investor, focus on whether your investments are generating real (after-inflation) returns, not how they are performing relative to their peers or a benchmark, Motala says.
The three main asset classes are equities, property and income-earning investments (bonds and cash). Of the three, Motala says that equities are the most volatile asset class, but provide the most protection against inflation risk. With property, the volatility is medium, as is the hedge against inflation risk. Income-earning investments are the least volatile asset class, but they provide the lowest protection against inflation risk.
If you are under the age of 50, the only way you will generate inflation-beating returns in your savings is to have most of your portfolio in equities and property. Even as you approach retirement, and once you have retired, you should not have all your assets in income-earning instruments, because you will continue to need protection against inflation risk, he says.
Motala says that in a low-return environment the quality of the investments in your portfolio has become a crucial driver of returns, because even a minor “mistake” can have a devastating impact on value. This means that picking high-quality stocks has become very important, he says.
You also need to ensure that your portfolio is appropriately diversified, not just across asset classes, but also market sectors, geographic regions and currencies, Motala says.
Referring to the collapse of African Bank, he says one cannot justify including a stock in your portfolio simply because it is cheap – in other words, because it is thought to be priced below its intrinsic value. Instead, a critical approach must be adopted when looking at the intrinsic value of a share – does it, in fact, have any? He says you need to look at, for example, the quality of the company’s assets, whether its earnings are backed by cash flows and whether it operates in a stable sector of the economy.