Big stock market declines are hitting pensioners hard. Here’s Why
It is pensioners rather than all investors, who are being really hammered right now. When you save money towards a long-term goal, such as retirement, you can endure dips such as Covid-19 and the 2008 subprime lending crisis.
One of the advantages of market dips, when you are building up savings on a regular basis, is that you are buying cheap assets that will gain value as markets improve again.
But when you retire and live on an income, based on your retirement savings, it’s very different. When you are drawing down income, you are reducing your capital at a far greater rate when investment markets collapse.
The pensioners, who are facing the greatest dangers, are those who are using investment-linked living annuities (Illas). And 90% of all pensioners choose this investment vehicle rather than the traditional life assurance guaranteed annuities (pensions).
Let’s say today, no matter how long you have been retired, you have retirement capital of R6-million. You are drawing down 7% of your capital a year, giving you R35,000 a month. (Be warned: At an average of 7%, pensioners are already in trouble, but it is the reality of how things are in South Africa).
The market then crashes by 20%, reducing your capital to R4.8-million. You stick to your R35,000 a month (R420,000 a year), because you can’t afford to live on less and you can only change the income levels on your annual anniversary date. This means that you are now withdrawing at a rate of 8,75%, but if we take inflation at 5%, your actual withdrawal is now a withdrawal of 13.75%. Your after-inflation capital is now worth R4,140,000
The following year markets level out, but do not recover and you continue to withdraw the same amount of R35,000.
In the third year, your capital has now reduced to R3.96-million and your drawdown is now at 10.66%.
By the end of year nine, you have reached your maximum drawdown of 17,5%. You have reached what is called the “point of ruin” where your income will drop in real terms and that is before inflation. In buying terms, because of inflation, your buying power reduced a few years earlier.
The problem now is that you will never know when investment markets will recover. For example, in nominal terms without inflation, the New York Stock Exchange took until 1952 to recover from the great depression of 1929; and Japan which reached the dizzy height of 30,000 in 1992 is still nowhere near that mark 29 years later.
The effects are likely to be more devastating for the South African economy. Around the world, we are seeing a far wider reach of problems related to Covid-19 than the property burndown.
Unlike 2008, we now have almost every industry involved, particularly in countries that are in virtual lockdown. For example, in 2008 shops, theatres and restaurants stayed open, and people were allowed to travel, but this is not the case with the Covid-19 crisis.
I strongly suspect that the investment market will take longer to recover this time as well.
But they should recover, particularly in countries that have cash on hand, such as western developed economies.
However, in South Africa, particularly after the National State of Disaster was declared by President Cyril Ramaphosa, recovery will be slower because the country is already desperately short of funds and is faced with the fallout of years of extensive fraud and corruption.
Then we have the Saudi Arabian and Russian fuel war, which has already shrunk the oil price internationally, and hit Sasol, a major contributor to the economy, reducing its share price by 95%.
Now let’s look at the proposed industry drawdown for pensioners proposed by the industry body, the Association for Savings and Investment South Africa (Asisa), and the draft proposals by the regulator, the Financial Sector Conduct Authority (FSCA) for a Standard for Illas relating to default annuities offered by retirement funds.
Asisa has a table that shows how long your income is likely to last before you hit the “point of ruin”: