Grant Alexander, Founder and director of Private Client Holdings
Given current longevity trends, it’s not unusual for people to live to 95. This means that they can spend up to thirty years living off the capital they spent forty or so years generating. For many investors, this wealth preservation phase is likely to be a longer term than they have planned for. It’s important therefore that investors do not derisk their portfolios too early and reduce their potential returns as they could face financial shortfalls in their later years.
The following example highlights the benefit of not derisking too soon.
A person starts his wealth generation journey in his 20’s and builds his savings nest egg until age 60. He invests in high equity funds throughout the wealth accumulation phase and preservation phase. This allows him to draw 5% pa of his capital to fund his lifestyle until he reaches 90.
This scenario only works if he remains invested in high equity funds. If he had derisked at retirement (65yrs) or suddenly got nervous about the markets and wanted to move from high equity to a typical income or defensive fund, he would have earned returns of inflation + 2%. While he may feel comfortable for a while by not experiencing the volatility in the markets, he will run out of money 11 years sooner than if he had remained invested in high equity funds.
The switch from high to low equity or income funds usually happens at the time when Retirement Annuities are transferred into Living Annuities. The reason for the underperformance is because most returns are realised after retirement. In fact, 87% of investment returns are generated during this phase. Unfortunately, most people think they should derisk at the point of retirement, which may be a monumental mistake.
It is advisable to have at least 60% of your portfolio invested in equities and between 25-55% in offshore assets to ensure that you maximise the probability of achieving successful lifestyle goals. From an investment perspective, investors must really take care not to derisk too much or too early. (Disclaimer: This does not constitute advice. Always consult with your wealth manager or financial advisor)
This is where your wealth manager is worth their weight in gold. It is important to establish this relationship during your wealth creation phase. Meet regularly so that your financial advisor understands you and what keeps you awake at night, your dreams and fears, and ensures that you remain on track with your wealth goals.
“Even the wealthiest of families are often resource constrained in their capacity to allocate financial, intellectual and social capital to their aspirations,” says Grant Alexander, a director at Private Client Holdings, a boutique multi-Family Office in Cape Town. “Sophisticated cash flow modelling software helps to represent client goals graphically, which enables us to track progress and the probability of success over time. We have regular check-ins to ensure that the client remains aligned as their goals evolve over time. The power of this process is that it keeps clients engaged and invested,” adds Alexander.
The industry generally treats the wealth generation and preservation phases differently and manages them according to a client’s risk profile, which may shift from growth to balance over time. Private Client Holdings treats both phases as a whole journey and not as two separate parts. The wealth creation mindset continues throughout the wealth generation and preservation journey, with defensive assets only used to fund relatively short-term (i.e. < 5 years) cash requirements, while the balance of capital remains invested in growth assets.
The company applies a Goals-Based Wealth Management (GBWM) approach, which involves spending time with a wealth manager or financial advisor to establish what your financial goals and priorities are. In most cases, the lifestyle goals (primary residence cost, food, living expenses, etc.) are the most important, with any excess capital applied to other goals like buying a second property, setting up a charitable trust or leaving a legacy. “We evaluate the timeline as to when the capital will be required and apply a risk and return profile and optimise the mix of assets to suit each goal independently. These strategies then run side by side, so the focus is on the journey towards the goals and not on short-term noise,” says Alexander.
Some people fear dying too soon, but in fact we should fear living too long! Outliving your capital is a daunting prospect, so make sure that your transition from wealth generation to wealth preservation is managed by a wealth manager who understands the implications of derisking too much and too soon.
ENDS
