How much should you be investing for retirement?
Your spending is likely to be divided into:
- Lifestyle expenses (monthly living)
- Lifestyle assets (houses, cars, etc. to enjoy the lifestyle)
- Investments (sustain the lifestyle in the future)
- Insurance products (protecting the lifestyle against catastrophe)
How much of your monthly spending pie should go toward the investment slice?
The answer depends on:
- The cost of the lifestyle you would like to sustain
- The time you have given yourself to build the capital base
- Your appetite for risk in the portfolio
The assumptions regarding retirement are these:
- You will live for 15 years in retirement.
- In retirement, you will invest conservatively and get a return of inflation +2%.
- The retirement income will increase to keep pace with inflation.
- After 15 years, the capital will be exhausted.
Think in today’s value of money. Work out your current expenses. In retirement, many of these expenses will disappear – installments toward debt, children’s expenses, and monthly investments such as retirement annuities. We refer to the amount that is left as your “lifestyle expenses” – the expenses that you would have if you were retired today.
Let’s say that you stripped out all of the above-mentioned expenses and were left with R10,000 per month. If this is the lifestyle you would like to sustain (expressed in today’s money), then how much would you need to save if you were starting today?
Look at the table below: If you had 30 years to go and you were comfortable with a moderately aggressive investment strategy (with a likely return of around 6% above inflation), then you would need to invest an amount equivalent to 16% of the desired lifestyle’s expenses to achieve this. In our example: 16% of R10,000 is R1,600 per month. Remember that the savings target relates to how much you spend to sustain your lifestyle and not to how much you are earning. Your monthly investment portfolio should be R1,600 over and above the lifestyle expenses of R10,000 per month.
Note that we are not talking about your income but rather about your lifestyle expenses. If your take-home pay is only R10,000, you will need to reduce your expenses until you are able to save an amount equivalent to 16% of your spending. This would mean cutting back until your expenses are R8,600 per month so that you could save R1,400 (which is 16% of R8,600).
Not voluntarily cutting back now will mean being forced to cut back when you get to retirement.
The table shows that if you have left your savings attempts until ten years before retirement and adopted a moderately low-risk investment, you would need to save as much as you spend (104%) on lifestyle expenses. If you waited until 5 years before retirement before starting to save, you would need to invest twice as much as you spend on lifestyle expenses.
| Yrs to save | Aggressiveness / risky-ness Investment strategy target | |||
|---|---|---|---|---|
| Conservative CPIX+2% | Mod/Conserv CPIX+4% | Mod/Aggressive CPIX+6% | Aggressive CPIX+8% | |
| 40 | 21% | 14% | 9% | 5% |
| 35 | 26% | 18% | 12% | 8% |
| 30 | 31% | 23% | 16% | 12% |
| 25 | 40% | 31% | 23% | 18% |
| 20 | 52% | 43% | 35% | 28% |
| 15 | 73% | 63% | 54% | 46% |
| 10 | 115% | 104% | 95% | 86% |
| 5 | 241% | 230% | 219% | 209% |
Assumptions:
- Inflation: 6% (note that a change in inflation will not alter the percentages by much).
- The amount you save will include contributions to a pension or provident fund.
Remember: Base your calculations on the cost of your lifestyle – not on your income.
