What if low returns are the new normal? Survival and growth strategies for your investments.
The performance of the Johannesburg stock exchange over the last 5 years has got every investor and Financial Advisor/Planner concerned. Many of us remember the times in the not to distance past where the JSE was giving us returns in high teens or twenties – no more.
When you’re putting a financial plan together, with or without some help, making assumptions are unavoidable. We Planners, have to make assumptions for the future on inflation, returns, tax, regulations, fees etc and our clients have to make assumptions like how much money they will need at retirement, if they will still have any debt or liabilities and at what age they are going to retire.
We also have to make assumptions on the returns that can be expected from each of the major asset classes (Equity, property, Cash and Bonds). Those assumptions for the medium and long term have worked for decades, but perhaps the model is broken – even if it is just broken for RSA Inc and not globally.
We usually measure the performance of an investment as CPI (Inflation) plus a certain percentage. This measure works well because the absolute minimum we should expect from an investment is that it keeps up with the “purchasing power” of the sum invested. When inflation is zero (as it has been in various parts of the West in the last decade) any return we get is a ‘reward’ for lending that money to someone else to use, in the case where there is inflation, the ‘reward’ is what we get over and above inflation. The RSA inflation rate in March 2019 was 4.4% (this is quite low by historical RSA standards and within the SARB target of 2-6%).
In the past we’ve always assumed that Cash will return about CPI or CPI minus 1%. In money market accounts (cash) you can expect anything between 5% and 7.4% and has been for years, in other words as high as CPI plus 3%. This is almost unprecedented. Bonds, both government and Corporate have been doing even better than this, and while we may equate it as being ‘like cash’ it actually is more of reflection of the amount of risk investors see in the country/company. These bonds have propped up many investments in the last couple of years (there has to be some upside to being considered a ‘high risk’ country to invest in, right?) Equity is usually assumed to return CPI plus 5% or more. In the last five years the JSE has returned 19.5% in total over the five years, or less than 4% per annum. THAT is what has everyone worried.
Eight years is usually seen as a full long-term cycle, and we are still not on track for CPI plus 5%, averaging out at just over 8% (or CPI plus 3-4%) in the last 8 years (without compounding), we’re going to have to see some pretty hefty returns in the next 3 years for the cycle and assumptions to get back ‘on trend’. This is in an environment where there are global cooling and fears of economic corrections in the next 2 years. We are so small from a global economic perspective (less than 0.5% of global GDP), and so dependent on global trade that we almost always get hit by a global recession.
The one place all of us are affected when it comes to lower than expected returns is in our retirement savings and investments. The only way to find out what impact this has on our own plan is to re-run the financial models behind those plans with new assumptions. Obviously, the closer you are to retirement, the more urgent this is going to be. In the simplest terms, when it comes to retirement and there is just not going to be enough in the “pot” to meet your expected lifestyle, there are a few options you can look at. You can put away more, you can optimise the asset allocation for the ‘new normal’ (change how it’s invested), you could plan to work longer (so that you can put away more and postpone the use of the investment) or you can lower your lifestyle expectations at retirement. Ideally, a mix of all these options is probably going to get the best result but is not going to be a stress-free exercise. Remember it is the markets that are giving you these returns, good or bad, and no planner worth his or her salt will take credit for a great performance. The planner’s role is to find the right asset allocations that will get you as close as possible to your long term objectives.
Long term investments have to be teamwork between client and planner. If meeting your long term objectives means that you have to make those difficult decisions to cut back on some of your spending, or lower your retirement expectations – these are not things that your planner can do for you. Look at the end goal, nobody wants to be in their late eighties and the money has run out – especially in this country where there is almost no social safety net for the elderly.
Action: Revisit your financial plans, specifically w.r.t the assumptions underlying those plans and adjust accordingly. Get your planner to run a couple of different scenarios so that you both can get a handle on how it needs to be managed to meet your long term objectives.