Preventing financial disaster in retirement – 8 pitfalls to avoid
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By Riaan Campbell
After a lifetime of building up to the pinnacle of your wealth creation efforts – being the day you retire – you have to follow only one rule: avoid disasters that will cause the permanent loss of capital.
The hard truth is that very few families manage to grow their wealth in retirement. And too many fall victim to scams or misfortune that materially threaten their financial future.
As we have seen in 2020, market volatility will always remain a risk that you have to manage. This problem is ever-present, even once you transition from accumulating your retirement savings to spending it. Strategies to mitigate these risks should form part of your financial plan, especially as these market risks are beyond your control.
Under normal circumstances, your retirement should remain secure if you have basic financial safeguards in place. But every so often, families find themselves in abnormal circumstances that threaten to undo their years of hard work and diligent saving.
Here are eight material risks to your retirement capital which, if you avoid them, will help you circumvent eroding wealth to a point where you can no longer achieve your retirement goals.
Some families believe that investments will save them from their spending strategy. Unfortunately, it will not because investments aren’t predictable. We think of spending as a percentage of your investable assets.
In order for this pool of assets to see you through retirement from your mid-sixties, we work on a rule of thumb of withdrawing no more than 5% a year. Anything less than 4% per year means you should have a very good chance to sustaining your wealth throughout your lifetime.
Managing your spending risk means managing for inflation, so your portfolio has to include inflation-beating assets and you have to be flexible in your spending. And then, of course, you need to manage your household overheads, which can sometimes be done by downscaling.
2. Family dynamics
An often-overlooked risk is failure to inform family and loved ones of your financial and legacy plans.
This makes succession planning so important if you have business assets that you want to pass on to the younger generations.
But the biggest risk in most families is if one, dominant person makes all the decisions. This is compounded if that person fails to groom younger family members to continue the business, or they are not aware of what the legacy plan involves.
3. Concentration risk
This is probably the most important aspect of financial planning when you enter retirement. This can take many guises, whether an over-concentration of assets in a particular stock, or market or property.
The threat is that one cataclysmic event can change the rest of your life. And Covid-19 is a prime example of the type of “Black Swan event” that you need to look out for.
So, you have to diversify your assets wherever possible.
One other way your retirement assets are threatened is if you are highly leveraged. Should some disaster happen, the income you derive from a rental property might dry up or the value of shares held by a bank as collateral on a loan might fall off a cliff.
If you are a forced seller in these circumstances, to extract yourself from the debt, you have no choice but to absorb the losses. Under normal circumstances you would be able to wait for prices to recover before selling, and thereby avoid the losses.
Failure to plan properly can result in sacrificing some assets that an efficient tax plan would otherwise have avoided.
Common reporting standards and the international clampdown on tax havens means there is nowhere left to hide. And depending on where your assets are held, you could be liable for taxes ranging from income, wealth and capital gains taxes to estate duties and inheritance taxes.
This is particularly relevant when assets are held in a business structure. You have to be aware of the complexity, flexibility and liquidity offered by ownership structures. Are you giving up control for the sake of tax?
In either event, you can turn complexity to your advantage by consulting advisors who can show you the best way to minimise your tax or using tax-friendly jurisdictions.
6. Scams, scandals and Ponzi schemes
These happen all the time, and South Africans have not been spared attempts to separate you from your hard-earned money. Pensioners are an obvious target because they are forever searching for higher returns.
It is no wonder then that people are attracted to schemes that offer higher “guaranteed” returns. But be aware that if the return is too good to be true, it is almost certain to be a scam.
7. Currency risk
A material risk that South Africans will be familiar with is the volatility of the currency.
If you find yourself at the wrong end of a currency movement, it can significantly affect your wealth. For example, in 2001 the rand lost 50% in about two months, to over R13 per US dollar. But then it appreciated by 50% to R6 per dollar and 10 years later it was still R7 per dollar.
We suggest that you choose a currency of reference. If you travel or plan to live in a different country then it makes sense to invest in assets that match the liability.
8. Sovereign risk
This threat of assets in a particular country losing value is not unique to South Africa because it happens across the world.
Radical tax increases, expropriation, and exchange controls are examples of what governments can do. Reckless fiscal and monetary policy will create hyperinflation. Venezuela is an example of how a populist government turned a once-flourishing economy into one of the greatest humanitarian tragedies in a hundred years for a country not involved in war.
The most effective way to minimise sovereign risk is to diversify your physical assets across multiple jurisdictions.
Preserving your wealth through retirement means actively avoiding these pitfalls. One way to do so is to partner with a wealth manager who is able to guide you and prevent you from losing your hard-earned capital.
Riaan Campbell is an Advisory Partner at Citadel