Research has shown that only 1 in 3 adults have any form of pension.
Submissions presented to Parliament this month by the retirement and savings industry in response to the Pension Funds Amendment Bill proposed by the DA, once again highlighted South Africans’ shockingly poor savings culture, their lack of providing adequately for their retirement and their lack of understanding proper financial planning.
Research has shown that only 1 in 3 adults have any form of pension, 49% have no retirement plan and 62% of pensioners cannot make ends meet. And there are more horror statistics that show a common lack of understanding of what financial planning and savings should entail.
Three important, linked phases
It’s not simply a matter of securing some funds for retirement at the end of one’s life as so many people erroneously believe. Planning, saving and investing for your financial wellbeing should be part of a holistic, life-long journey in financial planning and saving, and one that consists of three important, linked phases. Failing to properly understand these three phases of financial planning, could result in dire consequences.
This is according to Theoniel McDonald, someone with ample experience on this subject. McDonald is a Certified Financial Planner® professional and the managing director of Wealth Associates Central, strategic marketing director of Wealth Associates South Africa, as well as an elected director of the Financial Intermediary Association (FIA).
“Often, when talking to people, I am surprised by their poor understanding of what financial planning actually entails,” says McDonald. “There seems to be a common misperception that it amounts to someone simply trying to sell them a policy. This often leads to a lack of trust or appropriate action, resulting in bad risk management, low savings, bad investments and ultimately an inability to retire.”
McDonald says that once the three phases of financial planning as well as the different types of planners for the various requirements over these phases are fully understood, it will assist people to engage with the appropriate advisors who can guide them along their financial planning journey.
What are these 3 phases?
It starts with the risk management phase, which is arguably the least exciting one and often is perceived as the rather morbid necessity of purchasing products to cover various risks. The second one is the accumulation phase, when you can afford to start saving for specific needs and start accumulating capital for your eventual retirement.
The final phase, says McDonald, is the “sunset” or retirement phase when it all comes together at a point that you will most likely stop contributing towards retirement and will start using your capital to provide yourself with a regular income.
Risk management phase
This phase effectively begins when you start earning an income, says McDonald. The various components of this phase will include having a budget, medical aid, life insurance, short-term insurance, drafting of a will, building up an emergency fund and perhaps looking at trust and/or company structures. Advisors to assist you with each of these components will usually include a healthcare or medical aid advisor, financial planner, short-term broker or advisor, and a fiduciary consultant, lawyer or accountant.
“While advisors often work in more than one of these categories, the high levels of specialisation in different fields these days may result in you not receiving the specialised knowledge that you as a client may require. However, a multi-disciplinary advisor may be able to cater for clients with basic needs. Once the various risks are adequately covered, one should start focusing on the accumulation phase,” says McDonald.
With your “emergency fund” or risk provision hopefully now in place, you can start focusing on medium- and long-term savings – usually the beginning of the investment journey.
Essentially medium-term savings are focused on specific goals such as a deposit to buy property or a vehicle or pay for an overseas trip or some other extraordinary expenditure. Suitable products to cover this include money market funds, endowment policies, or unit trust funds among others. An existing bond could also be used as a savings account as you will effectively save the interest on the additional contributions made to the bond.
When focusing on long-term savings, you could consider investment options such as a share portfolio, tax-free savings accounts, direct property, unit trusts, retirement annuities, or a pension or provident fund, for instance.
“But it is crucial to understand the underlying product specifications as well as the underlying risk and expected return,” says McDonald. With long-term investing it is most important to understand that these investments are often volatile, and a long-term view should be maintained, he says. To achieve inflation-beating returns over the long-term, you should invest in a well-diversified portfolio consisting of most of the asset classes, says McDonald.
“It also is important to understand the tax implications of each investment. For instance, are the contributions tax deductible? Are there any capital gains tax, income tax or dividend withholding tax implications? Are the costs associated with the investment well disclosed and reasonable? If you work through an advisor, you should understand how he/she is remunerated for the advice and intermediary services. Some other costs may include fund manager and administration fees.”
“Costs are unavoidable and should be watched. But don’t become so deterred by costs that you end up with poor or no advice, resulting in inferior products or funds not suitable for your specific requirements,” says McDonald.
Having accumulated a fair amount of savings and approaching retirement, you now have to start planning the final phase of your financial journey.
During this final phase you reap the rewards of your discipline in the earlier two phases as you essentially no longer contribute towards retirement but draw from these funds to supplement or replace the income earned during your working career. McDonald stresses that this phase does not need to start at the age of 65 as prescribed by so many institutions.
“This phase can start the moment you have accumulated enough assets that can provide an income that covers your living expenses and can allow annual growth to cover the expected growth in income,” he says.
Advisors are important
McDonald says advisors play an important role to manage your expectations with regards to the income drawn from your investment as well as making sure that the asset allocation and product mix is suitable to your current environment. He points out that research has shown that clients with advisors make fewer emotional decisions during market corrections and ultimately end with more capital than those without advisors.
“Regular engagement with your advisor is more important than ever during the third phase as it is critical to make sure you are still on the right path and to make adjustments if need be,” he says.
Finally, McDonald says that understanding the three phases of financial planning will assist you in finding the correct advisor during each specific phase in your life.
“Make sure you engage with advisors that are experienced and qualified in each of the phases and who understand that mistakes made during the risk management phase could potentially be rectified over time, while mistakes in the retirement phase could result in an immediate reduction in your retirement income,” he says.