Playing catch-up: compound interest adds up to a comfortable retirement
If statistics are anything to go by, many South Africans delay saving for retirement. When we are young, retirement seems just a speck in the future, and other life expenses and events distract us.
While the best course of action is starting as early as possible and saving for as long as possible, there are still options available to you if you find your retirement is suddenly around the corner and you realise you haven’t saved enough. “It is never too late to play retirement catch-up,” says Jac de Wet, Head of Sales at PSG Wealth. “However, you need to be realistic and understand the trade-offs you need to make.”
Use your time wisely
Investors often think retiring comfortably is only about the amount of money invested. However, the period of investment is even more important. Saving for retirement can be summarised as easily as this: The earlier you start, the less you need to save monthly. The catch is just as easy: it’s not only about catching up on the amount of savings you have missed out on contributing (a challenge in itself). It’s really about catching up on the compounded returns you have missed out on.
Let’s look at an example to illustrate this. The table below shows that if you want to retire with an extra R1 million at age 65 and you start saving at age 25, you’ll need to save R180 per month. If you want to end up with R1 million at age 65 but only start saving at age 45, however, you will need to put away a far greater amount – almost R1 400 per month! The longer you postpone saving, the more you need to save, but, says de Wet, the table also shows that even at 45 and older, it is not too late to start.
Quantifying the impact of additional savings
What does an additional R1 million buy you at retirement? It could be an extra R4 100 to your monthly income (assuming a withdrawal rate of 5% from a living annuity). “If you ask any retiree, they’ll tell you that will make a vast difference to your standard of living,” de Wet says. “Keep in mind that the current old age pension grant in South Africa is only R1 700 a month.”
Calculating how much you need
The general ‘rule of thumb’ is that your monthly income during retirement should be at least 75% of your last monthly pay cheque to be able to retire comfortably. This is assuming that you won’t have large outstanding debts such as still paying off a car or house. This in turn implies that you will have fewer expenses and more disposable income. However, de Wet says it is best to make provision to live much longer than we may typically expect due to medical advancements and the associated costs, which could mean that a 90% ‘replacement ratio’ (instead of the commonly accepted 75%) may be more reliable for planning purposes.
An example of how much you’ll need to retire comfortably
If you were to retire at age 65 with a monthly income of R50 000 (R600 000 per year). You will need 90% of that (which would be R45 000 p.m. or R540 000 p.a.). Every year after retirement, this required amount will increase by roughly 6% (catering for inflation) and your retirement capital grows by 9%. Assuming you live until age 100, this means you will need to have saved more than R12.2 million by the time you retire.
Realistically reaching a bold retirement goal
The message is clear: regular monthly contributions early enough can make it possible to reach a bold retirement target. If you start at age 35 or earlier, it is much easier to achieve this than starting later. But remember that escalating your contributions to keep pace with inflation can make all the difference to your capital or enables you to catch up.
“Successful investing is about accumulating easy wins and watching them compound over time. Small incremental returns, day after day, month after month really add up, so you should make the most of this to help you reach a comfortable retirement,” de Wet concludes.