For your investment value not to shrink in real terms, it needs to grow at or above inflation, which over the last 20 years is an average 5.6% per annum after tax. To achieve this after-tax return, one needs to take on some risk. Earning a “risk-free” interest return (7.8% average money-market rate over the last 20 years) from the bank will not suffice if your effective tax rate is above 28%. The rate of tax on interest income is up to 45% which is much higher than dividends tax (20%) and capital gains tax (7% to 18%).
If you are retired and drawing on your investment for income, you will have to ensure your net investment value continues to increase (after regular withdrawals) to support the higher inflation growing withdrawals.
A guideline for retirement savings is not to draw more than 5% annually of your total savings. For your investment to support withdrawals that are increasing by inflation (6%), an annual average investment return of around 11% into perpetuity is required.
However, if you are prepared to deplete your investment capital to zero over 30 years, an annual average return of 8.5% would be required. This would be a risky strategy as you may need income for a longer period than 30 years, or funding in the event of an emergency.
If you invested in a Living Annuity, special care needs to be taken as you will be bound by the 17.5% p.a. income ceiling. For your Living Annuity to continue producing an escalating income for 30 years, a return of 9.8% per year is required.
Taking on risk in an uncertain/volatile environment
To beat inflation after tax, some risk assets need to be part of your investment portfolio.
Taking on risk means investing a portion of your savings in equities, property or bonds. SA equities and property have been volatile and have produced below inflation after-tax returns over the last 5 years of 4.5% and negative 2.2% p.a. respectively. However, over the last 15 years, SA equities and property have produced annual returns of 13.5% and 13.6% p.a. respectively. Bonds have returned 7.6% and 8.3% p.a. over the last 5 and 15 years respectively.
Ultimately, one should take on risk that suits your personal risk profile and stay invested for the long term to achieve inflation-beating returns. The problem is that often, we take on too much risk that we can’t stomach when markets are volatile. Frequently, this results in switching to a stable money market fund that we never leave and get trapped into a long-term erosion of our capital.
In uncertain times one needs a level of measured risk. Risk that specifically suits you, that you will maintain with some volatility. This requires an assessment of your investment goals and risk profile.
Our “Parking Strategy” for a stable income
If you are reliant on a stable income or just cannot tolerate longer periods of slow returns, we recommend adopting a “parking strategy” into our low-risk investment portfolio which has generated a return of 9% to 10% p.a. Once the environment appears more certain, we will recommend moving into more growth assets, which should generate double digit returns.
Consider our Prosperity Worldwide Fund
Our Prosperity IP Worldwide Flexible Fund of Funds has returned an average 9.5% p.a. over the last 5 years with a low risk investment strategy. The fund is conservatively managed with an objective to preserve capital as it seeks to generate steady after-tax returns above inflation. Its philosophy is to invest in irrationally priced global asset classes within very strict risk parameters.