MONEY CLINIC | How can I invest my R1.2m savings without eroding my capital?

A Fin24 reader set to retire this year is looking to invest his R1.2 million savings in order to receive a monthly payout. He writes:

I am retiring in a few months’ time and have a pension fund of around R1.5 million, which will not be enough to retire, but also have R1.2 million in savings, which l would like to invest, and have a monthly payout without eroding my investment. Any advice please? 

Michael Rossouw, Senior Investment Consultant at 10X investments, responds:

Capital erosion is a major concern for post-retirement investors. To counteract it, one needs to understand the factors that erode your capital. Every year there are three factors that are constantly reducing your capital:  

Inflation

Inflation is the general increase in prices, which causes a decline in the purchasing power of money. At the moment, inflation in South Africa is running at 4.5%. This means that your capital needs to grow by an annual rate of 4.5% in order for it to maintain its buying power. 

If your capital is growing by 4.5%, even though the rand amount is increasing, your buying power is not, because the costs of goods is growing at the same rate. 

Fees

The costs associated with investing are a major factor that erodes one’s capital. The higher the cost, the quicker the erosion. 

Unfortunately, the investment industry is not very transparent on what these costs are. To prevent confusion you should ask for your EAC (effective annual cost), which cuts through all the grey areas and tallies all the layers of costs into a single number. 

Most post-retirement investors have an average fee of around 2.5% per annum, which means their investment pot is reduced every year by this amount. 

Annuity income (drawdown rate)

This is the income you receive from your investment throughout the year to live on. 

Most investors draw an income out of about 4% of their investment every year. This means their capital is reduced by a further 4% annually. 

To balance the combined effect of these three erosive factors on your investment pot you need to look at your Minimum Required Return. This is the minimum return that your capital will need to grow by to ensure that your investment does not erode.

Given the example above, your investment would need to grow by 11% to cover inflation, fees and the annuity income. 

My advice to you would be threefold:

Choose a fund that is capable of achieving your minimum required return over the long run. Take a look at the fund fact sheet and see if the fund you are invested in has achieved your minimum required return over 1, 3, 5 and 10 years. If it hasn’t, then it’s not the right fund for you. 

Two, choose a sustainable income. Far too many investors are drawing an unsustainable income and land up eroding their capital. 

Thirdly, when the minimum required return is too high and an investor feels he or she cannot reduce their annuity income further the only factor left to change is to reduce the fee paid. This is where 10X Investments helps a lot of investors. 10X focuses on lowering costs down to 1% or less, without compromising returns. 

If you can lower your fee by 1%, or even 2%, of your investment’s value, it will lower your minimum required return and you will have a much higher probability of your money lasting in retirement.

Questions may be edited for brevity and clarity.