The fixed yearly return with the Discovery Enhanced Yield Fund

Discovery Invest has launched a structured product which might yield great returns for investors.

The Discovery Enhanced Yield Fund is designed to give you a high fixed return of 15%* in flat or positive markets.

How the Discovery Enhanced Yield Fund works

The Discovery Enhanced Yield Fund is available on the lump-sum Discovery Core Flexible Investment Plan and is only open from 18 June to 24 July 2018. With a minimum investment of R50 000, you will get a fixed return of 15%* if the FTSE 100 index shows flat or positive returns on the Discovery Enhanced Yield Fund’s first anniversary.

If the FTSE 100 index shows a negative return on the first anniversary, we will reinvest the funds for another year and increase your returns by another 15%*. The total will then be paid at the end of the second year if the FTSE 100 index return is flat or positive since inception.

We will continue to reinvest the funds and add 15%* to the returns each year until the FTSE 100 index provides a flat or positive return since the Fund’s inception. This will continue for up to five years.

Protect your capital in negative markets

In addition, the Discovery Enhanced Yield Fund offers you downside capital protection*. If the FTSE 100 index return is negative at the end of each of the years in the five-year period, we will provide full capital protection* at the end of the five-year period, if the FTSE 100 index has not fallen by more than 40% at any stage over the five years.

However, this capital protection* falls away if the FTSE 100 index fell by more than 40% at any stage over the five–year period. In this case, you will receive the return of the FTSE 100 index at the end of the five-year period if negative.

Please consult your financial adviser to get more comprehensive information on the Enhanced Yield Fund.

*The fixed return and capital protection is before the deduction of fees, such as Discovery administration fees, initial and ongoing financial adviser fees, withdrawal fees and tax, if applicable.

The above information should not be taken as financial advice. For tailored financial advice, please contact your financial adviser.

Discovery Life Investment Services Pty (Ltd): Registration number 2007/005969/07, branded as Discovery Invest, is an authorised financial services provider. Product rules, terms and conditions apply

Tax Consequences of Pension/Provident fund withdrawals at resignation

Tax Consequences of Pension/Provident fund withdrawals at resignation

Most of us will experience the process of resigning from an employer at some stage of our lives and, if you are lucky enough to receive a pension, you will be left with an important choice to make at that point.

I would like to share, in simple terms, the different tax implications when someone opts to take a 100% cash withdrawal at the point of resignation (before retirement age) or transfer their Pension fund to an approved Preservation Fund.

To understand the tax implication, there are three important aspects we need to understand:

The difference between Pre-Retirement and Retirement

  • Retirement, in normal circumstances, is allowed at the age of 55 or older
  • Pre-retirement, in normal circumstances, is before the age of 55

The difference between how Lump Sum or Pension Benefits will be taxed pre-retirement (Withdrawal Benefits Table)
and at retirement (Retirement Benefits Table), please see below:

Taxable Lump Sum Rate of Tax
0 – R25 000 0% of taxable income
R25 001 – R660 000 18% of taxable income above R25 000
R660 001 – R990 000 R114 300 + 27% of taxable income above R660 000
R990 001 and above R203 400 + 36% of taxable income above R990 000
Taxable Lump Sum Rate of Tax
0 – R500 000 0% of taxable income
R500 001 – R700 000 18% of taxable income above R500 000
R700 001 – R1 050 000 R36 000 + 27% of taxable income above R700 000
R1 050 001 and above R130 500+ 36% of taxable income above R1050 000

By simply looking at these tables, you will already have noticed the difference between the portions taxed at 0%:

R0 – R25 000 – Withdrawal Benefits Table

R0 – R500 000 – Retirement Benefits Table

The options available at resignation to the Taxpayer:

  1. Receive a cash lump sum
  2. Transfer the pension benefit to an approved Preservation fund (Pension Preservation of Provident Preservation) or Retirement annuity.
  3. Choose a combination of the two options (Excl. GEPF)

Planning for retirement? Retirement rules of thumb in South Africa

John and Jennifer (Jen) are 62 and want to retire comfortably soon. Can they retire now? They want to know how to set up their retirement income to give them the maximum income that will be reliable for the rest of their life.

They have been investing for years and have R10 million in retirement investments. Is that enough?

They make an income of R1 000,000 per year and are scared to stop working and give it up.

They went to see a financial advisor and received this advice:

  1. 70% Replacement ratio: They will need R700,000 per year income in retirement. Based on the “replacement ratio” rule of thumb, they will need 70% of their pre-retirement income.
  2. 4% Rule: They can withdraw R400,000 per year and increase it every year by inflation from their R10 million in investments, based on the “4% Rule”. Add roughly R300,000 from CPP and OAS to give them the R700,000 per year they need, so they have enough.
  3. Age rule: They are getting older so they should invest more conservatively based on the “Age Rule”. The should invest 100 minus their age in stocks. Since they are age 62, they should have 38% in stocks and 62% in bonds.
  4. Sequence of returns: They should invest conservatively because they can’t afford to take a loss. They could run out of money because of the “sequence of returns”. If they would have investment losses early in their retirement, their investments would not recover.
  5. Delay CPP to age 65: They were told this is a “guaranteed return of 7.2% per year”, because they will get 7.2% more for each year they wait.
  6. Cash buffer: They should keep cash on hand equal to 2 years of their income from their investments to draw on when their investments are down. Since they could withdraw R400,000 per year from their investments, they should keep R800,000 of their investments in cash.

John & Jen came to see me because they were still hesitant to quit their jobs. They said this advice is from rules of thumb and not specifically for them.

They asked me, “Is this good advice for us? Can we really retire now?”

I told them, “I see this type of canned advice a lot. These rules of thumb have been handed down from one generation of financial advisors to the next. The rules appear to be common sense and are usually accepted without question. Here are the first 3 things you need to know:

  1. You need a personalized Retirement Plan. Don’t base your future on rules of thumb.
  2. These rules of thumb are not supported by history. I studied 146 years of history of stocks, bonds and inflation and found these common rules of thumb are generally not You can read the study here: “How to Reliably Maximize Your Retirement Income – Is the “4% Rule” Safe?
  3. Maximum reliable retirement income. I can show you what really works to give you the maximum reliable retirement income – both how to set up your portfolio, manage your income and minimize your tax.”

We went through the Retirement Plan process in detail together. Here is what we decided:

Desired retirement lifestyle

John & Jen want a relatively comfortable retirement. They enjoy dining out and golf, want 2 reliable cars, and R100,000 per year for vacations. After we worked out their desired lifestyle in detail, they were surprised to find that they actually need R800,000 per year (R400,000 each before tax) to live the lifestyle they want.

I told them the 70% replacement ratio rule of thumb might be a reasonable average, but everyone is different. I have prepared Retirement Plans with as low as 45% and as high as 150% of preretirement income.

Decide on the life you want to live. Don’t settle for the income you get.

Investment allocation

John and Jen’s investments now are two equity funds and two balanced funds. They have 75% in equities and 25% in bonds. I asked how they felt about this mix. They said they had owned them for years and are comfortable with this risk level. They owned them in the crash in 2008 and did not sell.

However, they asked, “But should we invest more conservatively when we retire. Our time horizon is shorter and we can’t afford to take a loss, right?”

concept image used for article. Subject: how much is enough for retirementI told them they have a long-term time horizon and history does not support a safer retirement from investing more conservatively. They should invest based on their risk tolerance, not based on how they think they should invest.

Their time horizon is long. They are 62. In 50% of Canadian couples in their 60s, at least one of them makes it to age 94. Planning for their money to last until age 94 would be a 50% chance of running out of money. It would be better for them to plan for no more than a 25% chance of outliving their money. There is a 25% chance that one of them will live to age 98.

That means John and Jen have a 36-year time horizon, which is definitely long-term.

We had a detailed discussion of their risk tolerance. They confirmed they are comfortable with their existing investment risk. They would stay invested even in a large market decline. We decided to keep their investments at 75% in stocks and 25% in bonds.

Target withdrawal rate and the Age Rule

A target withdrawal rate can be an effective way to manage your retirement income after you retire, but 4% is not reliable for most seniors.

John & Jen asked me, “If we withdraw R400,000 per year (4%) from our $1 million in investments each year and increase it by inflation, is that reliable for the rest of our life?”

I told them that, based on history, the “4% Rule” was safe for equity-focused investors, but not for most seniors. In the image below, the blue line is the “4% Rule”, showing how often in the last 146 years a 4% withdrawal plus inflation provided a reliable income for 30 years with different portfolio allocations.

The

I explained that the “4% Rule” worked only if you invest with a minimum of 50% in stocks. Even safer is 70-100% in stocks. It is best to avoid a success rate below 95% or 97%. They mean a 1 in 20 or 1 in 30 chance of running out of money during your retirement.

I asked John and Jen how they felt about a 1 in 20 chance (95% success rate) of running out of money. They said a 1 in 30 chance felt better.

Most seniors invest more conservatively and the 4% Rule failed miserably for them. A “3% Rule” has been reliable in history (green line), but means you only get R300,000 per year plus inflation from a R10 million portfolio, instead of R400,000 per year.

Based on the “Age Rule” of thumb, John and Jen had been advised to invest 62% in bonds and increasing that by 1% every year. In a 36-year retirement from age 62 to 98, they would average 80% in bonds.

John and Jen were shocked to find that their chance of a successful retirement would only be 69% if they used the “Age Rule”. (Note the blue line for a 20/80 portfolio allocation.)

Since we had decided on 75% in stocks and 25% in bonds, the 4% Rule is reliable for them. It has worked 97% of the time in history.

John & Jen found this counter-intuitive. They asked, “The more you invest in stocks, the safer your retirement income would have been in history?”

Yes. To understand this, it is important to understand that stocks are risky short-term, but reliable long-term. Bonds are reliable short-term, but can be risky long-term. Why? Bonds get killed by inflation or rising interest rates. If either happens during your retirement, you can easily run out of money with bonds.

The next chart illustrates this clearly. It shows the standard deviation (measure of risk) of stocks, bonds and cash over various time periods in the last 200 years. Note that stocks are much riskier short-term, but actually lower risk for periods of time longer than 20 years.

Stocks are more reliable after inflation for periods of time over 20 years.

After seeing the history, John & Jen finally felt comfortable with a 4% target withdrawal rate for them, since they plan to maintain their 75% allocation to stocks.

Sequence of returns

John and Jen asked, “What about the ‘sequence of returns’? What happens if we have some bad investment years early in our retirement?”

I told them the “sequence of returns” is not supported at all by history. Retirement is long and stocks have almost always recovered any loss throughout history – even when you continue to withdraw your retirement income from them.

I showed them the charts below, based on US market history data since 1871 from Standard & Poors, Barclays and Bureau of Labour Statistics, which show actual history of the 4% Rule with 3 different investment allocations. Each line is a 30-year retirement. To see how successful retirement would have been, note how often the lines go below R0.

With 100% in equities, the success rate was 97%. There are 118 retirements of 30 years on this graph. Investing 100% in stocks, you would have run out of money only 5 times – 4 because of very high inflation and one because of a market crash.

Notice that there was a market recovery within a few years of almost all market declines, even though you continued with the same retirement income and increased it every year by inflation. There were quite a few market crashes in the last 146 years, but only once would you have run out of money because of a market crash (retiring in 1929).

In other words, the sequence of returns was an issue only once in the last 146 years.

Actual retirement success history: 100% equities with 4% withdrawal + inflation

Most seniors invest more conservatively, such as with 70% bonds and 30% stocks. Their success rate was 86%. The data below shows that they would have run out of money 17 times.

Actual retirement success history: 70% bonds / 30% equities with 4% withdrawal + inflation

4% Rule with 70% bonds and 30% equities – 86% success rate.

Because of the “sequence of returns”, the typical advice is to invest more conservatively with more bonds. This is not safer! The risk of running out of money with 70% in bonds is 3 ½ times higher than with 25% in bonds.

Then there’s the 4% Rule with 100% in bonds. There are 118 retirements of 30 years on this graph. Investing 100% in bonds meant you would have run out of money in 63 of them – more than half the time! If you retired almost any year between 1890 and 1980, you would have run out of money with 100% in bonds. Note how many of these lines drop below R0:

Actual retirement success history: 100% bonds with 4% withdrawal + inflation

4% withdrawal with 100% bonds – 47% success rate.

I told John and Jen, “Don’t worry about sequence of returns. As long as you follow your plan, invest within your risk tolerance and stay invested, your investments can recover from almost any market decline.”

Start CPP at retirement

I explained to John and Jen that delaying CPP is not a “guaranteed rate of return of 7.2%”. They get 7.2% more CPP during their life and then their spouse gets 60% of that if the spouse outlives them. The rate of return depends on each specific situation but is closer to 5%.

Whether to take CPP early or delay it depends on many factors. I showed them my studies of “Should I start my CPP early?” and “Should I Delay CPP & OAS Until Age 70?“. They showed that how you invest is one of the main factors. In general, equity investors should take CPP earlier, while balanced and bond investors should delay it.

Now that I know their situation, I recommended to John and Jen to start their CPP at retirement.

Cash buffer

John and Jen asked whether they should hold cash equal to 2 years’ withdrawals to draw on when your investments are down. Then they could live off the cash and not touch their investments after a big down year, giving them some time to recover.

I told them that this sounds logical, but was not supported by the 146-year study. For example, assuming 100% in equities and various cash holdings, here are the success rates for a 30-year retirement with 3 different withdrawal rates:

The highest success rate is No Cash. It is safer NOT to hold cash.

In every case, holding cash either had no effect or increased the risk of running out of money. I could not find a single example of a retiring year or withdrawal amount when holding any amount of cash provided a higher success rate than holding no cash.

The study showed that holding cash does not protect you. In fact, it often increases your risk of running out of money. The drag on your returns from holding cash sometimes caused you to run out of money, but holding cash never protected you from running out of money.

This might be counter-intuitive. The reason is that retirement is long – say 30 years. Stocks usually recover from declines. Holding cash for 30 years means you lose out on a lot of income, plus the loss of purchasing power due to inflation.

In addition, if you hold cash, you will almost definitely die with a significantly smaller estate to pass on to your loved ones.

I told John and Jen, “It is safer not to hold cash.”

Retirement plan

John and Jen still have their original question, “Can we safely retire now?”

We created a proper retirement plan. Instead of using rules of thumb to estimate how much they might need, we used retirement planning software. I showed John & Jen that they need R10.15 million in retirement investments to have the retirement they want. They are 15% short.

Their retirement plan allows them to plan their life with 3 choices:

  1. Retire now at age 62 on R730,000. We discussed what lifestyle expenses they would cut R70,000/year. They could buy R200,000 cars instead of R300,000 cars and cut their travel from R100,000 to R60,000 per year.
  2. Work 1 ½ years and retire at 63 ½ on their desired $80,000 per year.
  3. Retire now on R800,000 with an advance retirement income strategy. There are many ways to manage your retirement income. My study found methods that had 100% success in history with withdrawal rates of 5% and even 6% of your investments if you manage your withdrawals effectively and can take a small decrease in some circumstances. You should be careful with these higher methods. They require carefully managing your income.

John and Jen prefer option B, to retire on their desired lifestyle. They realized from this process that they are not fully ready to retire today. They now have confidence they can retire in about 1 ½ years.

Jen said, “The retirement plan is very helpful for us to plan our life.”

Summary and tested advice on retirement income

What is the best way to set up your retirement income to give you the maximum income with the lowest risk of running out of money?

  1. Get your Retirement Plan. Plan your desired retirement. Work it out in detail so you are confident. Don’t use an “income replacement ratio”. Decide on the life you want to live. Don’t settle for the income you get.
  2. Equities are safer. Don’t assume you need to invest more conservatively just because you are retired. Retirement is for 30+ years. Consider keeping the same allocation you had before retiring. Equities are also taxed at much lower rates than bonds and GICs.
  3. You need cash flow, not income. Invest for long-term total return and then withdraw the cash flow you need. Don’t focus on income, like interest or dividends, if they would reduce your long-term total return. Systematic withdrawals (or “self-made dividends“) give you control and are the lowest taxed investment income.
  4. Equity investors can safely use the 4% Rule, as long as you invest at least 50-70% in equities.
  5. The “Age Rule” works with a “3% Rule”. There is nothing wrong with investing conservatively with the Age Rule, but then reduce your retirement income to withdraw only 3% of your investments each year. Fixed income is lower income. The more conservatively you invest, the lower your retirement income should be.
  6. Don’t worry about the “sequence of returns”. Worrying about it can lead you to hold more in bonds, which actually increases your risk of running out of money. Retirement is long and stocks have reliably bounced back in history.
  7. Be smart about your risk tolerance. Invest with the highest amount in stocks that is within your risk tolerance. That means you cannot make the “Big Mistake” – sell or invest more conservatively because of a market decline. The more conservatively you invest, the more likely you will run out of money (at any withdrawal amount). Get educated on stock and bond market history, so you have an accurate picture of risks and returns.
  8. Inflation is huge. Inflation typically makes the cost of living triple during your retirement. You need a rising income, not a fixed income. Inflation kills bonds, but not stocks.
  9. It is safer NOT to hold cash. Holding cash does not protect you and may increase your risk of running out of money. It almost definitely means you die with a smaller estate.
  10. Higher income is possible with effective management. You can have a higher income by withdrawing 5% or even 6% of your investments if you can manage your income effectively or are working with a financial planner who knows how to manage it effectively.

Thank you Ed Rrempel for your insight.

https://edrempel.com/can-retire-now-ed-rempel-tests-retirement-income-rules-thumb/ .

Investing vs Saving

Investing versus saving

Saving can be a simple act of holding on to money. By not spending a certain amount of capital, you preserve that for a specific reason like unforeseen realities or future purchases when you have enough capital.

Saving can be an act of money in a drawer or safe or in a bank account with a fix interest. Most important to keep in mind about saving is the risk of inflation. Inflation is the amount you could lose on the value of your money.

Saving money with an interest rate of 3%p.a and inflation of 5.5% would mean you are effectively loosing 2.5% of your moneys value each year. Even worse, if you put it in your safe you will have 0% growth and loose 5.5% each year.

 

Investing has a much wider description and greater expectations. It can be done by actively participating or passively engaging by paying a management team to manage your money with the aim of increasing your capital above the inflation margins.

Let’s break down investing to the basics. Trading goods or services for profit creates an income for the trader. The other aspect is supply and demand which result in a value increase or decrease like buying property.

John want to increase his capital and find ABC PTY is looking for funding to help expand their operations in order to grow their market penetration to other cities. John gives R100 000 to ABC PTY for a 10% share in the company.

The claimed value of ABC PTY is thus R1 000 000. They take the money and setup an office in a new town which brings in revenue. Over twelve months they increased the value of ABC PTY to R1 100 000. The increase of share value for John is now R110 000. An increase of R10 000 or 10%.

There are many risks in starting your own business or investing in a business someone told you about and you can easily loose ALL your money.

Investing in stocks simply means you will be buying shares or fractions in companies with thousands or millions of shares. Companies who list on the stock exchange are vetted and needs to meet minimum requirements to allow a less risky participation by the public.

Most retail investors choose to invest in mutual funds. A pre-selected basket of listed companies. Mutual funds have certain mandates within risk categories. These can include listed property(Mostly shopping centres/hotels/corporate buildings etc, equities (business trading) , bonds (a bond is an instrument of indebtedness of the bond issuer to the holders).

You also have to keep in mind that sometimes international companies and currency plays a part in beating local inflation.

Investment in trade shares or property requires you to decide on a timeline for example 5, 10 or 15 years. This is important because a company might make a large investment in tools or land which will only result in an income growth in 18 months, which means they might not beat inflation or even be negative for the short term but make a significant growth after engaging their trade and starting the increase of sales.

There are many factors to consider, including sentiment in a particular company or political changes local or across borders. Fund managers have to do research not only on the company and its management, but also the possibility of changes in industries and country politics.

These factors are not clear cut and thus allow for both risk and growth opportunities. The risk of investing are many times refer to as opportunity cost.

If you do not pay opportunity cost your capital will most likely deplete due to the increase of living expenses which is called inflation.

We will look into various investing and its risk and opportunities in more detail with future updates.