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Towards a sustainable retirement plan
By Daniel R Wessels
The conventional approach to retirement planning & advice
• Retirement capital required to sustain an annuitant’s real income (annuity) over the long term (25-30 years after retirement)
• Retirement capital ratio (factor of final salary)
• The minimum savings rate required to meet the required retirement capital
• The maximum withdrawal rate allowed at retirement to sustain annuity income over the long term
The conventional approach to retirement planning & advice
Relationship between replacement rate, initial withdrawal rate and retirement capital ratio
50% Replacement
70% Replacement
100% Replacement
0.00%
2.00%
4.00%
6.00%
8.00%
10.00%
12.00%
14.00%
8 9 10 11 12 13 14 15 16 17 18 19 20
Retirement capital ratio (factor of final salary)
Init
ial w
ith
dra
wa
l ra
te
The basic premise of this approach is that we assume that future
returns will be similar than what we experienced in the past…
But is this a realistic assumption?
For example, consider three different investment
portfolios and their long-term historical returns… •Low-equity portfolio (25% equities, 75% bonds and cash):
•Medium-equity portfolio (50% equities, 50% bonds and cash):
•High-equity portfolio (75% equities, 25% bonds and cash):
Portfolio Nominal Real Volatility
Low-equity 9% 4% 9%
Medium-equity 11% 6% 14%
High-equity 13% 8% 18%
Annualised portfolio returns (1900-2010)
Low-equity portfolio
Real Portfolio ReturnAnnual Returns
-40%
-30%
-20%
-10%
0%
10%
20%
30%
40%
50%
1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010
Real
Ret
urn
per a
nnum
Real Portfolio Return
Real Portfolio ReturnRolling 30-year return
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
1930 1940 1950 1960 1970 1980 1990 2000 2010
Annu
alis
ed R
eal R
etur
n
Real Portfolio Return
Medium-equity portfolio
Real Portfolio ReturnAnnual Returns
-60%
-40%
-20%
0%
20%
40%
60%
80%
1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010
Real
Ret
urn
per a
nnum
Real Portfolio Return
Real Portfolio ReturnRolling 30-year return
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%
8.0%
9.0%
1930 1940 1950 1960 1970 1980 1990 2000 2010
Annu
alis
ed R
eal R
etur
n
Real Portfolio Return
High-equity portfolio
Real Portfolio ReturnAnnual Returns
-60%
-40%
-20%
0%
20%
40%
60%
80%
100%
1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010
Rea
l Ret
urn
per a
nnum
Real Portfolio Return
Real Portfolio ReturnRolling 30-year return
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
1930 1940 1950 1960 1970 1980 1990 2000 2010
Ann
ualis
ed R
eal R
etur
n
Real Portfolio Return
In all instances we note secular periods of high and low real portfolio returns, i.e. a
period of high real returns is followed by a
period of lower real returns… Real Portfolio ReturnRolling 30-year return
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%
8.0%
9.0%
1930 1940 1950 1960 1970 1980 1990 2000 2010
An
nu
ali
se
d R
ea
l R
etu
rn
Real Portfolio Return
Therefore, determining a savings rate to acquire a certain retirement
capital ratio and/or a withdrawal rate that will sustain the retirement plan
over time may be futile because long-term real returns are not
consistent
For example, the savings rate required to meet a certain retirement capital amount at retirement would have varied considerably
over time…
Minimum Savings Rate to meet Target Retirement Capital
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
30.00%
Year at which saving for retirement started
Sav
ing
s R
ate
Minimum Savings Rate
Likewise, the maximum initial withdrawal rate that would have been allowed to ensure a retirement plan sustaining a real income over time varied
from as low as 4% to high as 12% in the past…
Maximum Withdrawal Rate
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
14.0%
Year at which retirement period started
Pe
rce
nta
ge
of
Re
tire
me
nt
Ca
pit
al
Maximum Withdrawal Rate
And the retirement capital (retirement capital as a factor of final salary) required would have varied
considerably …
Minimum retirement capital required to sustain retirement plan over thirty years
Replacement rate = 70%
-
2.00
4.00
6.00
8.00
10.00
12.00
14.00
16.00
18.00
20.00
22.00
24.001
90
0
19
05
19
10
19
15
19
20
19
25
19
30
19
35
19
40
19
45
19
50
19
55
19
60
19
65
19
70
19
75
19
80
Re
tire
me
nt
ca
pit
al r
ati
o
(fa
cto
r o
f fi
na
l sa
lary
)
The Targeted Retirement Capital approach:The higher the long-term real returns, the lower
the required savings rate or higher the safe withdrawal rate…but you won’t know this
beforehand!
Minimum Savings Rate to meet Target Retirement Capital
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
30.00%
Year at which saving for retirement started
Savi
ngs
Rate
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%
8.0%
9.0%
10.0%
Real
Ret
urn
Minimum Savings Rate (lhs) Rolling 30-year real return (rhs)
Maximum Withdrawal Rate
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
14.0%
1900
1905
1910
1915
1920
1925
1930
1935
1940
1945
1950
1955
1960
1965
1970
1975
1980
Year at which retirement period started
Perc
enta
ge o
f Ret
irem
ent
Cap
ital
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%
8.0%
9.0%
10.0%
Rea
l Ret
urn
Maximum Withdrawal Rate (lhs) Rolling 30-year real return (rhs)
Alternative Solution:
Focus on the full cycle of the retirement plan, i.e. contribution period (30-40 years) and withdrawal
phase (25-30 years)
Then the question would be how much of my salary should I save each year to ensure that I will
have sufficient retirement capital to sustain my retirement income over the long term?
Minimum Savings Rate required over time…
35-year contribution period, 30-year withdrawal period, 70% replacement rate, constant real income (annuity)
Minimum Savings Rate required to sustain retirement plan over full cycle35-year savings, 30-year retirement
6.0%
8.0%
10.0%
12.0%
14.0%
16.0%
18.0%
Start of 65-year cycle
Pe
rce
nta
ge
of
inc
om
e
Minimum Savings Rate
Safe Savings Rate based on historical evidence…
35-year contribution period, 30-year withdrawal period, 70% replacement rate, constant real income (annuity)
The percentage of retirement plans sustainable over a 65-year lifecycle
Savings Rate 10% 11% 12% 13% 14% 15% 16%
After 10 years retirement 100% 100% 100% 100% 100% 100% 100%
After 15 years retirement 81% 100% 100% 100% 100% 100% 100%
After 20 years retirement 34% 57% 85% 100% 100% 100% 100%
After 25 years retirement 11% 32% 47% 66% 91% 100% 100%
After 30 years retirement 0% 13% 32% 47% 64% 91% 100%
Safe Savings Rate based on historical evidence…
The contribution period, replacement rate at retirement and portfolio selection all play a key role…
But the contribution period is probably the most important determinant…
Sustainable retirement plan based on historical evidence…
Retirement plan sustainable for 25 years
Sustainability of retirement planReplacement = 50%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
25 30 35 40
Contribution period
Su
cc
es
s r
ate
of
reti
rem
en
t p
lan
to
su
sta
in in
co
me
fo
r tw
en
ty-f
ive
ye
ars
aft
er
reti
rem
en
t
10% Savings rate
12.5% Savings rate
15% Savings rate
Sustainable retirement plan based on historical evidence…
Retirement plan sustainable for 25 years
Sustainability of retirement planReplacement = 75%
0%
20%
40%
60%
80%
100%
25 30 35 40
Contribution period
Su
cc
es
s r
ate
of
reti
rem
en
t p
lan
to
su
sta
in in
co
me
fo
r tw
en
ty-f
ive
ye
ars
aft
er
reti
rem
en
t
10% Savings rate
12.5% Savings rate
15% Savings rate
Practical considerations for investors
• Start early – from your first pay cheque
• Keep the discipline of saving regularly, despite good or bad periods that you’ll experience over time
• At retirement: Do not go over the top! Stick to your budget and plan (do not withdraw more than you initially planned for and think twice about buying that car!)
• Retirement is not where you stop applying your mind and skills. Empower yourself to earn additional income from your specialised skills, hobbies or interest during the retirement years.
Practical considerations for financial planners
Most likely the planner will be approached by investors at or near retirement, not at the start of their working careers! Thus, the financial planner must advise on what is available, not what could or should have been.
Err on the conservative side in planning and projections
Identify low-cost administrative investment platforms and investment portfolios, which benefits are obvious in a lower real return scenario, but are easily hidden or forgotten in buoyant years.
Practical considerations
Relationship between replacement rate, initial withdrawal rate and retirement capital ratio
50% Replacement
70% Replacement
100% Replacement
0.00%
2.00%
4.00%
6.00%
8.00%
10.00%
12.00%
14.00%
8 9 10 11 12 13 14 15 16 17 18 19 20
Retirement capital ratio (factor of final salary)
Init
ial w
ith
dra
wa
l ra
te
Possible "Safe Zone"
Thank you
The full research report can be requested at: [email protected]
Daniel R Wessels
Martin Eksteen Jordaan Wessels ccFinancial advisorsFSP 12406 2nd floor 5 St GeorgesSt Georges MallCape Town8001 021-4193134 (t)021-4193390 (f)
DRW INVESTMENT RESEARCH
Disclaimer:Please note that all the material, opinions and views herein do not constitute investment advice, but are published primarily for information purposes. The
author accepts no responsibility for investors using the information as investment advice. Please consult an authorised investment advisor.
Unless otherwise stated, the author is the sole proprietor of this publication and its content. No quotations from or references to this publication are allowed
without prior approval.
