Spending and saving 16 November 2012
Hang on to financial discipline
How can examining your spending and saving help if investment volatility over the past 12 months has put your retirement plans under pressure?
Depending on the timing of entering or exiting certain investments, your retirement plans may well have been adversely affected.
What can you do to ensure that your long-term plans withstand the current volatility and allow you to be able to enjoy the retirement you have been looking forward to?
Get the balance right
Firstly re-examine your budgets and financial commitments, ensuring you balance spending and saving.
Even in the tough times, maintain your discipline towards saving a portion of your monthly income. Maintaining a savings mentality will go a long way to ensuring that your retirement nest egg continues to grow.
If you are within a couple of years of retirement, you may want to consider deferring retirement for a year or two, or working part-time as a consultant. This has the added benefit of helping with the transition to retirement and also keeping you mentally active.
Hang in there
Where you have existing disability or life cover or other financial commitments in place, avoid cancelling them. Not only will the cancellation likely have costly penalties attached, but the risk policies are an integral part of your financial plan, specifically in the asset accumulation phase.
If you cancel the policies and you have dependants, if something unforeseen happens, it will likely cause financial devastation to your family.
A further part of examining your budget is ensuring that you manage debt levels, specifically short-term debt. This carries the highest interest rate, and should be settled as quickly as possible.
Avoid switching investments.
There is a big temptation to switch out of a certain asset class, i.e. shares, cash, bonds or property, into another. There was a lot of talk over the past year about investors switching in to cash.
By doing this we assume we have the ability to time the market. This strategy has been shown not to beat a buy-and-hold strategy. Equities will also outperform cash over time. Devise a long-term strategy together with your financial planner and then stick to that strategy, throughout the peaks and troughs.
Remember – when we maintain our spending and saving regime and the markets retract, we are buying more shares for the same amount of money. We will, therefore, be in a more favourable position when the market recovers.
Rebalancing is still important
You should still rebalance your portfolio from time to time. Asset allocation is the best way to achieve your desired results. However, don’t throw the baby out with the bathwater.
By switching 100% into cash, we are speculating on our ability to time the recovery of the market. If we get it wrong, we stand the chance of missing out on the opportunity to take full advantage of the recovery. Portfolio diversification is the best means to provide consistent returns at reduced investment risk. We just need to make sure that we are doing this in tandem with our financial planner, who has a holistic view of our financial situation and our financial aspirations. By doing this, we can ensure that we take as much, or as little, risk as we are comfortable with to achieve our goals.
Use all your tax breaks
You can maximise tax efficiency by firstly utilising the provident fund savings capacity of 20% of your taxable earnings, and then further by utilising your maximum tax-efficient retirement annuity saving capability of 15% of non-retirement funding income.
Assuming that you are in the 40% tax bracket, you can effectively save 2/3 more by utilising a retirement annuity as opposed to a unit trust.
Tax saving example – an extra two-thirds invested
If you wished to invest R1,000 of after-tax money each month in an investment vehicle, you could put this directly into a unit trust. Alternatively, you can invest a pre-tax amount of R1,667 in to a retirement annuity.
The after-tax cash-flow impact is identical at R1,000 (R1,667 – 40% tax relief), yet you are saving 66.67% more.
To illustrate further, this additional R667 per month, over a 30-year horizon earning a 4% real return, results in an additional R462,000 as opposed to the unit trust.
That is significant.
Plus, there is no tax on interest within the retirement annuity vehicle.
We should utilise our maximum retirement deductible tax allowances each year, as any portion that is not utilised does not get carried forward to the following tax years.
Do the paperwork
Ensure that you have a documented financial plan. How do you know when you have achieved your objectives if you do not know now what they are?
It is important to write this down with your family and an independent professional. A CERTIFIED FINANCIAL PLANNER® can help map your way to your retirement goals.
You should then review your plan on a regular basis, taking in to account changes in your financial and personal situations.
If you do not know a CFP®, visit the Financial Planning Institute’s website on www.fpi.co.za to select one
Debbie Netto-Jonker CFP® is the founder of Netto Financial Services and was Financial Planner of the Year in 2001.