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A look at how the interest rates affect retirees

By Opinion Time of article published Dec 24, 2020

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Many South Africans have celebrated the recent interest rate cuts and the fact that it is at record lows.

Debt is cheaper, home loans and car finance are more affordable – this is all good news in the current bleak Covid economy.

However, it is not good news for everyone – pensioners who are drawing an income from cash investments will be suffering a substantial decline in their monthly income – as much as a third of their earnings may be gone, which is a large amount of money to do without when living on a pensioner’s budget.

This is according to Grant Alexander, director at Private Client Holdings, who says that the reality is that many people drawing an income from a living annuity or from discretionary assets are, in fact, drawing down on capital.

“Pensioners drawing down on capital must revisit their monthly budget and make certain that the level of income being drawn from your investments can last over the planned retirement period. “Cut any unnecessary expenses and only keep the very bare minimum. Draw as little capital as possible as a monthly pension because each withdrawal while markets are down locks in financial losses. To continue drawing a high income when returns are low could permanently damage your retirement fund - the trick is to balance your income needs with the essential need to preserve capital for as long as possible.”

Diversification remains essential

Alexander advises that it is not bad news for all retirees and says that if retirees’ assets are properly diversified and provision has been made to at least keep up with, if not beat inflation in the longer term, then they will weather this period of low interest rates well.

“One needs to look at equities, fixed income instruments that are of a longer duration than pure cash, and hopefully include an offshore allocation.”

“The way in which assets are priced is off a risk-free rate. If you have a risk-free rate that has reduced, or reduces over time, the value of the retiree’s long duration fixed income assets increases, because the present value of those future cash flows becomes much higher.”

According to Alexander, it seems counter intuitive, but if the long bond yields go down, the value of fixed income assets actually increases. “Bonds pay a fixed interest rate that is more attractive if the interest rates in the market decline, which drives up the demand and the price of the bond.”

The same principle applies to the valuation of companies – the value of shares is the present value of all future cash flows. A discount rate is used when calculating the present value and that rate is constructed from the risk-free rate. Again, the lower the discount rate, the higher the present value of all future cash flows.

“In other words, there’s been an increase in valuation and an increase in the value of assets owned by diversified retirees because of this low interest rate environment. From an inflation beating point of view, that particular component of a retiree’s assets has actually done very well which, to a certain extent, offsets the negative impact of low interest rates on the shorter-term cash component of the total portfolio.”

“To summarise, retirees who don’t only have cash, but a diversified portfolio with a component allocated to beating inflation, are enjoying improvements in their portfolio’s because of the low interest rate - so they should be protected and come out ahead over time.”

Look ahead – buy now if you can

According to Alexander, in this type of market it is easy to be blinded by all the sentiment and short-term volatility prevalent in the system. “This has the potential to dissuade you from acquiring appealing long-term investments opportunities at attractive prices. You won’t have to search too long and hard to find some good investment opportunities – you just have to take a more rational view.”

Surviving volatility with a good fund manager

It’s at times like these, when financial markets are shifting and investors nervous, and when the value of a diversified, inflation beating portfolio becomes evident, that the shrewd investor realises the true worth of a professional financial planner who keeps you on course to meet your investment goals.

“One of the qualities of a good fund manager is the ability to apply a consistent investment framework over full market cycles, but also being mindful that the fundamental drivers of economies change over time,” concludes Alexander.

PERSONAL FINANCE

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