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
Initial withdrawal rate
14.00%
100% Replacement
12.00%
10.00%
8.00%
70% Replacement
6.00%
50% Replacement
4.00%
2.00%
0.00%
8
9
10
11
12
13
14
15
16
17
18
Retirement capital ratio (factor of final salary)
19
20
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):
Annualised portfolio returns (1900-2010)
Portfolio
Nominal
Real
Volatility
Low-equity
9%
4%
9%
Medium-equity
11%
6%
14%
High-equity
13%
8%
18%
Low-equity portfolio
Real Portfolio Return
Rolling 30-year return
Real Portfolio Return
Annual Returns
6.0%
40%
Annualised Real Return
Real Return per annum
50%
30%
20%
10%
0%
-10%
-20%
-30%
-40%
1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010
Real Portfolio Return
5.0%
4.0%
3.0%
2.0%
1.0%
0.0%
1930
1940
1950
1960
1970
1980
Real Portfolio Return
1990
2000
2010
Medium-equity portfolio
Real Portfolio Return
Rolling 30-year return
80%
9.0%
60%
8.0%
Annualised Real Return
Real Return per annum
Real Portfolio Return
Annual Returns
40%
20%
0%
-20%
-40%
-60%
1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010
Real Portfolio Return
7.0%
6.0%
5.0%
4.0%
3.0%
2.0%
1.0%
0.0%
1930
1940
1950
1960
1970
1980
Real Portfolio Return
1990
2000
2010
High-equity portfolio
Real Portfolio Return
Rolling 30-year return
100%
12.0%
80%
10.0%
Annualised Real Return
Real Return per annum
Real Portfolio Return
Annual Returns
60%
40%
20%
0%
-20%
8.0%
6.0%
4.0%
2.0%
-40%
-60%
1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010
Real Portfolio Return
0.0%
1930
1940
1950
1960
1970
1980
Real Portfolio Return
1990
2000
2010
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 Return
Rolling 30-year return
Annualised Real Return
9.0%
8.0%
7.0%
6.0%
5.0%
4.0%
3.0%
2.0%
1.0%
0.0%
1930
1940
1950
1960
1970
1980
Real Portfolio Return
1990
2000
2010
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
30.00%
20.00%
15.00%
10.00%
5.00%
0.00%
19
00
19
04
19
08
19
12
19
16
19
20
19
24
19
28
19
32
19
36
19
40
19
44
19
48
19
52
19
56
19
60
19
64
19
68
19
72
19
76
Savings Rate
25.00%
Year at which saving for retirement started
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…
14.0%
12.0%
10.0%
8.0%
6.0%
4.0%
2.0%
Maximum Withdrawal Rate
80
75
19
70
19
65
Year at which retirement period started
19
60
19
55
19
50
19
45
19
40
19
35
19
30
19
25
19
20
19
19
15
10
19
05
19
19
00
0.0%
19
Percentage of Retirement Capital
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%
20.00
18.00
16.00
14.00
12.00
10.00
8.00
6.00
4.00
1980
1975
1970
1965
1960
1955
1950
1945
1940
1935
1930
1925
1920
1915
1910
1905
2.00
-
1900
Retirement capital ratio
(factor of final salary)
24.00
22.00
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
Year at which saving for retirement started
Minimum Savings Rate (lhs)
Rolling 30-year real return (rhs)
1.0%
0.0%
1980
1975
1970
1965
0.0%
1960
0.0%
2.0%
2.0%
1955
0.00%
4.0%
1950
1.0%
Year at which retirement period started
Maximum Withdrawal Rate (lhs)
Rolling 30-year real return (rhs)
Real Return
4.0%
3.0%
1945
5.00%
5.0%
6.0%
1940
2.0%
8.0%
1935
3.0%
7.0%
6.0%
1930
4.0%
10.00%
10.0%
1925
5.0%
9.0%
8.0%
1920
15.00%
12.0%
1915
6.0%
Real Return
7.0%
20.00%
10.0%
1910
8.0%
19
00
19
04
19
08
19
12
19
16
19
20
19
24
19
28
19
32
19
36
19
40
19
44
19
48
19
52
19
56
19
60
19
64
19
68
19
72
19
76
Savings Rate
25.00%
14.0%
1905
9.0%
1900
10.0%
Percentage of Retirement
Capital
30.00%
Maximum Withdrawal Rate
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)
16.0%
14.0%
12.0%
10.0%
8.0%
6.0%
19
00
19
03
19
06
19
09
19
12
19
15
19
18
19
21
19
24
19
27
19
30
19
33
19
36
19
39
19
42
19
45
Percentage of income
18.0%
Minimum Savings Rate required to sustain retirement plan over full cycle
35-year savings, 30-year retirement
Start of 65-year cycle
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
Success rate of retirement plan to
sustain income for twenty-five years
after retirement
Sustainability of retirement plan
Replacement = 50%
100%
90%
80%
70%
60%
10% Savings rate
50%
12.5% Savings rate
40%
15% Savings rate
30%
20%
10%
0%
25
30
35
Contribution period
40
Sustainable retirement plan based on historical evidence…
Retirement plan sustainable for 25 years
Success rate of retirement
plan to sustain income for
twenty-five years after
retirement
Sustainability of retirement plan
Replacement = 75%
100%
80%
10% Savings rate
60%
12.5% Savings rate
40%
15% Savings rate
20%
0%
25
30
35
Contribution period
40
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
14.00%
100% Replacement
Initial withdrawal rate
12.00%
10.00%
8.00%
70% Replacement
6.00%
50% Replacement
4.00%
2.00%
Possible "Safe Zone"
0.00%
8
9
10
11
12
13
14
15
16
17
18
Retirement capital ratio (factor of final salary)
19
20
Thank you
The full research report can be requested at:
enquiries@indexinvestor.co.za
Daniel R Wessels
Martin Eksteen Jordaan Wessels cc
Financial advisors
FSP 12406
2nd floor 5 St Georges
St Georges Mall
Cape Town
8001
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.