Should you take on more financial risk ahead of retirement?

Your retirement is far from the end of your investment journey. Your savings must continue to accumulate, or you could run out of money.

Investment risk is an integral part of wealth accumulation, but it must be handled with caution. This article examines how investment risk can make or break your retirement nest egg.

Tip: Saving for retirement is the best gift you can give yourself. Learn more about retirement savings here.

Key financial determinants

Three components determine retirement outcome, says Craig Sher, head of research and development at Discovery Invest. These include:

• How early you start saving, or how long you save.
• How much you save.
• How much you draw down, and how quickly you deplete your savings when you retire.

Are your savings sufficient?

The amount you should save for retirement is subjective and differs from one person to the next.

“As a guideline, 75% of your last salary is considered ‘enough’,” says Wouter de Witt, co-founder of Gravitas Tax and a certified financial planner at Liberty Group. “The rule of thumb is to save about 15% of your income. The earlier you start, the less money you have to stash away every month to reach your target.”

“When you start saving at around 20 years of age, you need to put away only 8% or 9% of your salary every month, whereas if you start at 40, you need to save a whopping 25% of your salary. This is because, at 40, your investment has 20 years less in which to grow.”

Free online tools can help you calculate how much you need to save every month to ensure you have enough money for retirement.

Should you take on more investment risk?

Investment risk is one of the biggest threats to your retirement savings. While a risky approach may be considered “bad” and a conservative approach “good”, the truth is that an overly conservative outlook can be your downfall, says Sher.

“Risk is a double-edged sword. The further you are from retirement, the more you should invest in riskier asset classes like shares and equities,” he says. “These will likely give you a higher return in the long term.

“The closer you get to retirement age, the shorter your investment horizon becomes. This is when you need to start moving to more conservative assets, such as cash or money market instruments.”

De Witt cautions that the more risk you take, the more you stand to lose. Shares, for example, are volatile, as we have seen this year.

“Shares can go up 20% in a year but can also fall 20% in a year. Cash doesn’t go up more than 5 or 6% a year – but it also doesn’t go down.

“The more risk you take, the more growth you have in the longer term, but your pension will go up and down from year to year. If you’re close to retirement – say 55 or 60 – perhaps take on less risk because you can lose quite a bit and don’t have time to catch up over the years,” he says.

Once retired, rather than dispensing with risk, it’s much wiser to manage it, says Sher. You may live for 30 years further, given advances in medicine. For this reason, an overly conservative approach will not be to your benefit.

By way of example, 6% of a savings pot of R5 million at retirement will give you R300,000 per year or about R25,000 per month. However, if your R5 million is not growing, you will reach the bottom of the pot much sooner than you might expect.

De Witt agrees, saying the most significant risk in retirement is running out of savings.

“The problem is that money doesn’t keep pace with inflation. On retirement, you tend to withdraw more from your investment than it can accumulate. This means that each year your income will erode. The rising cost of food, fuel, and medical costs will compound the effect,” he points out.

Work with a financial adviser

Taking on more risk at any life stage should be weighed against variables such as your age, needs, financial market performance, and interest rate. It’s best to work with a financial adviser for this reason, as tempting as it may be to believe you can handle your own financial planning.

“People would often rather save the fees or commission payable to a financial adviser,” says Sher. “The reality is that a good financial adviser will ensure that these costs are returned to you in multiples. You will also have a proper financial plan that considers your expected longevity based on your habits and health,” he points out.

Tip: Unit trusts can help you reach your savings goal and grow your retirement pot. Find out more here.