There are rafts full of financial advisers out there. So the first question in financial planning is often ‘who should I use?’
The relationship with a financial adviser is, first and foremost, very personal. So my answer is often ‘find someone that you like and who will listen to you!’
There are financial advisers who rule the consultations with big financial jargon and calculations. These are the ‘financially literate’ advisers. One could be forgiven for presuming that all financial advisers should possess this skill.
Most investors are looking for a financial adviser who can explain the basic philosophies of a financial plan in layman’s terms. These are the ‘financially articulate’ advisers. How they get to their answers is of secondary importance.
Then one wants to see a big brand backing the financial adviser and the recommended products. That helps you sleep better at night. It is worth far more than an extended CV, smart suit and car.
A good financial adviser listens to what the investor wants. And then explains how the suggested product meets the investor’s needs. That is why I am a lecturer and could never be a financial adviser; I am hopeless at listening to others.
How much is enough?
‘How much is enough?’ is the next most common question in financial planning. Only the really wealthy don’t ask this question.
Yes, there are extremes of wealth in South Africa, but the ultra-wealthy are very few and far between. According to SARS statistics there are currently less than 90 000 South Africans with taxable income of greater than R1 million per annum.
The overwhelming majority of South Africans will need commitment, luck and skilful financial planning to preserve their wealth in retirement. They are not truly wealthy.
There is no universal financial model to answer the question. And there probably never will be. The answer is dependent on a range of variables that change with the wind. This is complicated further by changes in the investor’s needs and aspirations.
‘How much is enough?’ is a moving target that is about as worth pursuing as the gold at the end of the rainbow.
Off balance sheet assets and liabilities
Accounting 101 starts with the formula A=L+C (assets = liabilities plus capital). Capital basically represents accumulated wealth or C=A-L.
Accountants are historians and usually get uncomfortable when confronted with futuristic thinking. So the formula only looks at known liabilities at a particular point in time. This is very misleading in the context of financial planning.
A (assets) can also be misleading. I may own boats, cars and toys. But they are almost irrelevant in the context of financial planning unless I sell them. Assets also create liabilities in the form of upkeep and maintenance commitments.
Assessing ‘off balance sheet assets and liabilities’ is an integral part of financial planning.
For many South Africans, the bulk of their true wealth should be their retirement savings (RS). And their biggest liability is their retirement capital requirement (RCR), the liability of looking after a person who is no longer working. These are not considered in the formula C=A-L.
So perhaps the formula for the true measurement of capital/wealth in the context of financial planning should be: A+RS-L-RCR=C
Back in the days when employers provided defined benefit pension funds, RS was the employer’s problem. If one achieved 30-plus years of service RS would generally be sufficient to offset RCR. Thus wealth could be measured using the standard formula of C=A-L.
But for most of us the days of defined benefit funds are long gone. This has frightening implications.
For example: A person aged 65 with a R10-million home and no home loan may be wealthy applying the formula C=A-L. But in the absence of RS the RCR may leave the investor in negative territory (even though assets exceed liabilities) and actually insolvent in the long term.
The task of the financial adviser is to manage A and RS. But no matter how brilliant the financial adviser may be, the net result is not effective if the investor does not manage L and RCR.
RCR is heavily dependent on three factors:
- Life expectancy
- Rate of return
- Lifestyle of the investor
Much is made of the effects of increased life expectancy being the biggest problem in financial planning today. Living longer increases RCR, but, in my opinion, is far from the biggest issue.
South Africans get confused on the issue of life expectancy. This is probably due to the national life expectancy being around 53 years. This statistic is very misleading and should be discounted in financial planning. Those South Africans who have had access to medical aids and have not been exposed to physical labour generally live far longer.
The World Health Organisation (WHO) surveys conclude that life expectancy is increasing by approximately 1,5 years per decade. So, in theory, I should live three to five years longer than my dad. I can compensate for that by working three to five years longer. I can live with that! But I cannot presume that my employer or clients will.
Research conducted by the WHO predicts that a South African who survives to 60 has a life expectancy of 76 for males and 78 for females.
Nevertheless over 20 years of saving I can probably find the additional capital needed to provide for increased life expectancy.
Of far greater significance is that my retirement expectations are completely different from my dad’s. He was content with basic accommodation, food and a newspaper. A defined benefit pension fund was designed to do just that. In his case RS = RCR. Thus, so long as A>L there was no problem.
Dad’s retirement package did not envisage a cell phone, internet access, DStv, expensive car, GPS tracker (his car wasn’t worth insuring, let alone tracking).
Dad did not have to deal with the Eskom debacle (12,8% increase forecast for next year), electricity and fuel levies (surely to be increased substantially in 2015) and even the effects of carbon emission taxes (still scheduled for 2016). He didn’t have to pay for security or the pool and he didn’t live with monster pets.
Dad’s retirement package included comprehensive medical aid cover. Yes, I will have access to a medical aid, but I will have to pay for it with my pension annuity. RCR: R500 000 absolute minimum.
I want all that dad enjoyed in retirement and a whole lot more. And I don’t have a defined benefit pension fund to help. Aside from the effects of inflation, rates of return and life expectancy, just my retirement lifestyle will double my RCR over my dad’s.
My retirement expectations are not the only problem. Next up comes the issue of expected returns in retirement. This was not a problem for dad. His pension income was largely based on years of service. How much he had ever contributed to the retirement fund was more or less irrelevant.
Dad did not need a financial adviser. The spare cash sat in a savings account yielding a pre-tax return of up to 10% above the inflation rate. He didn’t even have to think about maximising returns. Today, with interest rates approximately equivalent to inflation rates, savings accounts are more or less irrelevant in financial planning.
Dad’s life philosophy was ‘he who dies with one rand wins.’ Many have far greater aspirations and want to leave a legacy. They want some C left at the end of the day. This narrows down the options substantially as A (assets) are not accessible to bolster RS if necessary.
The lifestyle plan
Ask a prospective pensioner ‘what are your plans for retirement?’ and the reaction is generally a blank stare. ‘What are you talking about? I’m staying right here in my family home. And I hope to spend more time with my grandchildren and take long holidays at our cottage at the coast.’
This is where retirement plans go so horribly wrong. RS has little prospect of covering RCR.
Some say they could survive 20 years in retirement on R1 000 per day (R30 000 per month, after tax and providing for inflation). Assuming inflation at 6%, a return on capital of 12%, the RCR would be in the region of R5 million. Others want a whole lot more.
The biggest shortfall of many financial plans is that they are not based on a sustainable lifestyle plan.
The fundamental questions that have to be confronted in evaluating RCR are:
· Where am I going to live?
Few South Africans have any realistic prospect of maintaining multiple residential properties in their retirement. The RCR created by utility costs of property ownership will simply consume their RS.
For many, the cost of servicing a residential property over 20 years will be equivalent to the value of the property. Do the calculation using the ‘cost of cave calculator’ available on http://criticalthought.co.za/financial-planning-calculators/
Multiple residential property ownership in retirement is out of the question unless the running costs can be shared or recovered through rental.
Since 2008 many South Africans have procrastinated over the decision to reduce their residential property portfolios. They dream that the residential property market will recover and the fantastic returns of 2002 to 2007 will somehow reappear.
Today we are probably further away from a residential property boom than we ever have been.
· Am I going to involve my family in my retirement plans?
This is probably the most difficult question in lifestyle planning. The prize is that the family that can live together stands to achieve massive economies of scale and thereby reduce RCR.
In America the ‘six-parent family’ is fast emerging. Grandparents educate children aided with iPads while parents work. Utility costs and even the investment in the family home are shared.
The six-parent-family formula may well be the answer for South African families with insufficient RS to cover RCR. But in as much as such plans work on paper, they can be a financial disaster if a serious family dispute emerges.
Going back to the question, ‘which financial adviser should I use?’, the answer is another question that is often ignored: ‘what is your lifestyle game plan?’ This is not a question the financial planner can answer or manage. And it is probably the most important question in financial planning today.