Investment Principles
Getting started with your retirement savings
Stepping into adulthood comes with a lot of new responsibilities, and saving for retirement may not be a top priority for young people who are focused on tertiary education and making early career choices. However, the need to save for retirement is clear, and it is necessary to equip oneself with the necessary skill set and tools to do so.
…financial literacy, disciplined saving and the power of compound interest are three powerful tools for young people saving for retirement.
Recent academic studies estimate that only 24% of South Africans actively save towards retirement, and for many years, National Treasury has cited that only 6% will retire with sufficient resources for a financially secure future. With medical advances leading to an increase in life expectancy, and with the rising cost of living, financial literacy, disciplined saving and the power of compound interest are three powerful tools for young people saving for retirement.
Financial literacy
Many worry that traditional pension systems may collapse under demographic pressures and that retiring might not even be an option due to the rising cost of living. Some countries are reducing public pension levels for future retirees, putting pressure on the younger generation to bridge the gap through private savings. So how do you ensure that you have enough? And how much is enough?
Financial literacy is the greatest asset available to a young person striving to achieve sufficient and secure savings at retirement. Understanding how financial and retirement products work and appreciating the cost of participating in the products are core requirements for successful saving and investing. While legislation puts more emphasis on fair treatment of customers and clear and transparent communication, some avoid investing simply because they don’t know where to start.
Disciplined saving
Saving from the time that you receive your very first income creates lifelong healthy savings habits and is one of the most impactful financial decisions you can make. Various studies show that financial constraints are the primary barrier to young people participating in formal retirement funds. If you learn to live off 95% of your income right from the start, and save the remaining 5%, then setting aside money for a rainy day or retirement becomes routine and alleviates a lot of fears around financial security.
Compound interest
Albert Einstein is famously credited with referring to compound interest (in other words, interest on interest) as ‘the eighth wonder of the world’. He explained its immense financial impact with the quote: “He who understands it, earns it. He who doesn't, pays it”.
Consider the following simple example. If you were to start consistently contributing 7.5% of your salary to a retirement annuity from the age of 25, assuming an average net return of 10%, your investment could grow to provide you with an estimated 75% of your pre-retirement income by age 65. Using similar assumptions, if you were to delay starting to save until age 40, you would need to contribute 19% to get to a similar result. This rate is almost 2.5 times higher – a heavy price to pay for not starting to save early enough.
Evolving pension systems and products
Many of the silent generation and baby boomers benefitted from pension systems that provided defined benefits guaranteed for the duration of their retirement. However, the ever-increasing cost of these systems – in part the result of increased life expectancies – has resulted in a shift towards defined contribution funds. While this system allows fund members to choose their investments and contribution amounts, it places the full responsibility on members, who are often ill equipped to understand the investment markets, the costs involved, and the risks they may be exposed to.
To address this, countries like the Netherlands and the UK have moved to a pension system that combines these two ends. In these systems, savings are bulked together in ‘mega funds’, and drawdown (pension payment) levels are managed by financial and risk experts. This system aims to provide members with a sustainable and stable income for the remainder of their lifetimes after they have retired. This method of bulking combined with compulsory saving, is also used in Australia, with their compulsory superannuation system.
Gen Z leading the way
On a positive note, worldwide research shows that Gen Z is increasing savings through micro-savings and AI-driven apps that automatically round up expenses to save. Unlike older generations, Gen Z tends to favour a non-linear career with multiple jobs, and they attach greater importance to private savings instead of employer plans.
While access to a personal financial adviser might seem out of reach initially, great advances are being made in relation to online access to financial retirement products with guided investment paths. With investment research made available through these online platforms, the financially literate youth can set out confidently on the path to financial security in retirement.
At the start of this article, I mentioned that only 6% of South Africans have sufficient retirement savings, but it is my sincere hope that the new generation of young people can use the tools available to them to change these sticky statistics and ensure greater financial security for their futures.
Offshore investing offers South Africans a valuable way to diversify their portfolios and access global opportunities. However, it requires careful planning within the legal and tax framework. Contact PSG Wealth on 0860 774 774 or at clientservice@psg.co.za for more assistance in navigating this complex landscape and making informed decisions that are aligned with your financial goals.
Share
