The millennial’s guide to a comfortable retirement

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01 June 2016 | Nonhlanhla Kunene

What do millennials and their baby boomer parents have in common? The inability to retire comfortably due to a lack of adequate savings.

Following in the not so ideal footsteps of their baby boomer parents, millennials, according to research by UBS Investor Watch, are heading towards the same pitfall more than half of their parents find themselves in: the danger of not having enough of a nest egg to afford a comfortable retirement.

Research does, however, take a holistic approach and acknowledges the unique circumstances millennials face – those who entered young adulthood in 2000 so are now in their early 30s – when compared with their predecessors. More than any other previous generation, millennials are faced with the challenge of already being in debt by the time they receive their first salary, with study loans making up a relatively huge portion of this debt. While student loans are justifiable, they’re not the only challenge millennials are confronted with: easily available credit from financial and retail institutions add to their debt pressures.

Debt is not the only challenge millennials are confronted with, however. When considering that only 6% of South Africans are able to retire comfortably, the majority of millennials face the added burden of falling into what has been termed the sandwich generation. A generation of young professionals who face the dual task of taking financial responsibility for more than one household, usually their own and those of their extended families.

These are just a few of the unique dynamics that leave millennials in a position where they often feel they are simply not in a position to invest for retirement.

Given all of these factors, how then does the average millennial overcome it all and alter the course of his/her future prospects to a more favourable one? What should they be prioritising, servicing the debt or saving towards retirement?

CFP Head at Momentum personal adviser services, Frank Magwegwe believes this is a challenge facing millennials across the globe, in varying degrees. “In South Africa, it is more the sandwich issue, while in the USA it’s student debt.”

Magwegwe says it shouldn’t be viewed as a case of debt vs retirement, but a case of debt and retirement. He believes millennials should make use of the maximum allowable contributions to employer retirement funds. They should then structure payment of debt, and supporting others on net pay after these pre-tax contributions, to ensure they benefit from time in the market and the power of compound interest.

Roenica Tyson, investment product manager at Glacier by Sanlam, says the question of debt versus retirement is always a tricky one because the immediate circumstances faced by individuals in their day-to-day lives will usually have an impact on their financial decisions. “However, you have to consider that millennials are living longer. With that come the added costs, including the costs of health care which you may need more of when you’re older. This makes the required nest egg to retire comfortably even bigger. So when you take that into consideration, we always say do not defer starting. The more time you have to invest the less you need to be able to put away because of the power of compound interest.”

Emphasising Tyson’s point is a representative from one of the major insurance houses who wanted to remain anonymous. “The earlier you start saving for your retirement, the longer you have for your investment to grow, and a small amount to start off with will grow into a healthy long-term investment.”

Further urging millennials to stop delaying, he said: “People who start earlier, even with smaller amounts of money, will have more in the long run compared with people who put larger amounts aside later.”

22seven CEO Christo Davel feels the more immediate priority is not choosing between debt and retirement, but finding the money to do either. “Until then, it’s academic,” says Davel. “The practical solution is to find money, and we believe that there is almost always some money to be found. Sometimes people don’t know where or how, but in most cases there is some money hiding – it may be R100 a month or R1,000. Once you know where it is, then you can think about the ‘debt or retirement’ question practically.”

In addition to financial constraints this group has proven to be quite averse to investing on the stock market, preferring to hold cash. This, to some extent, stems from the 2008 financial crisis and the adverse effects it may have had on their parents, including their ability to retire comfortably. This then begs the question of how to best address this fear of volatility while ensuring their investments can withstand inflation?

Tyson feels most investors are caught between the need to ensure their investments can beat inflation while minimising the impact of volatility and the risk of capital loss – which are factors to consider when investing in growth assets such as equities.

“For millennials, investing for retirement is a long-term goal and they still have time on their side. Looking at the South African equity market over the past 30 years, your real returns (after taking out the effects of inflation) could have been anything between -40% and 68% over any one-year period – a highly dispersed outcome. But as you invest for longer periods these ranges become narrower and the risk of loss that comes with equity investing decreases.

“Looking at a 10-year time horizon, for example, the (JSE’s) all share index delivered positive real returns ranging between 2.4% and 15.3%. As millennials have 30 to 40 years before retirement, short-term volatility shouldn’t be a concern.”

 

To tackle these, Magwegwe suggests the language used to socialise investment in stocks should move away from the usual, ‘If you invest in stocks you will reach you retirement goals’ advice, and start emphasising loss by stressing how people may not reach their future goals if they fail to invest. He says research suggesting humans feel more “pain” when faced with stock market losses shows that the emphasis on loss is a better catalyst for behavioural change than an emphasis on gain. Stating that language should also be about the inability to meet life goals if not enough risk is taken by investing in stocks.

A separate study by Deloitte on millennials spanning seven key markets, including China, the UK and US, suggests this crop of young adults would be more receptive to the idea of saving for retirement if there was greater flexibility in terms of access to the funds before retirement.

The investment industry is also seeing a gradual shift from the baby boomers’ firm belief in the use of financial intermediaries to the DIY approach, which most millennials seem to favour. Could this imply that traditional investment methods and retirement products may become obsolete? How are financial institutions adapting in order to meet these new demands and trends?

Davel feels it is difficult for financial institutions to adapt to this DIY trend because their businesses are built on the professional adviser approach. He believes real innovation is likely to come from the tech industry, in the same way that technology has disrupted other traditional industries such as taxis, entertainment and travel.

“Our own studies suggest that millennials are keener to manage their money themselves. They’re more likely to do their own research and reading; they’re likely to listen to their peers. And the stuff they’re likely to respond to is objective, neutral, honest information,” Davel suggested. “They don’t want to be sold to or talked down to. They want to be informed, but not necessarily ‘advised’,” he said.

In Tyson’s view, the industry is already evolving to meet these needs through the rise of robo-advisers: online services that provide automated, algorithm-based advice. “Even traditional intermediaries are adapting the way they engage and are moving towards becoming more digitised as they see the need to catch the younger clients, who may soon become the main decision makers as they grow older or take over their parents’ investments as heirs.”

And what is the industry’s take on robo-advisers? “I think if the investment needs are simple then robo-advisers are a good start to get into the savings discipline. But what they don’t consider is a holistic financial plan. This is where intermediaries play an important role, in that they take into account an investor’s entire life plan.”

What about the debate of retirement annuities (RAs) versus tax-free savings accounts (TFSAs)? Given the millennials’ need for greater flexibility in in their investments, are pension funds and RAs still really the only plausible means to a healthy retirement?

RAs are still the best plausible option in Tyson’s view, given the immediate tax benefits. “Unlike pension funds which were designed for their (millennials’) parents who stayed in their jobs under one employer for longer periods, millennials are known to change jobs multiple times during their careers. RAs become useful because they offer flexibility in terms of contributing and allows preserving retirement savings when you change jobs.”

With employer pension funds, Tyson believes millennials are often tempted to take the cash when changing jobs – which results in paying a lot of tax and making it more difficult to attain retirement goals. She does stress, however, that when opting for an RA over a pension fund, investors should ensure they have adequate life cover, as this is not included.

Magwegwe maintains that the best vehicle for the formally employed is through their companys’ retirement funds as the contributions are pre-tax and costs are low. For those not in formal employment, he feels the RA is best as savings in can only be accessed from age 55 and are unavailable for emergencies, unlike those in a TFSA.

In his view, TFSAs  are not ideal retirement savings vehicles because of the R30,000 annual limit to contribution and the R500,000 lifetime limit. He feels they’re more suitable as additional retirement savings, or other long-term goals such as saving for education.

Presenting an alternative perspective, Davel believes that while retirement funds have some definite advantages, RAs are not the only plausible means to a healthy retirement.  He says TFSAs might be an easier way to get started than RAs because they’re more flexible. “You can put money in once off and you’re not locked in until a certain age.”

So is it all doom and gloom for the millennial who hasn’t started saving for the future? Should they be starting to panic if they haven’t already started?

Not at all, according to Davel, who says it’s never too early or too late. “Of course it’s brighter if you start sooner. The earlier you start investing, the more your money will grow. There are plenty examples to show how investing less and starting younger beats investing more and starting older.”

Tysons agrees that putting it off further is definitely not going to help. “When you have to make up for lost time you’ll have to put down more money or delay your retirement. Ultimately though, it’s not all doom and gloom because time is still on their side.”

There is definitely time to catch up if it is not left too late, Magwegwe concurs. Although it would mean making maximum contributions towards retirement funding, and also having discretionary retirement savings.

Magwegwe acknowledges however, that the longer an individual puts it off, the harder it is to catch up. “If Thabo starts saving R1,000 a month at 25 for 40 years, and Thandi starts saving R2,000 a month at age 35 for 30 years. At 65, Thabo would have more money than Thandi. The 10 year late start by Thandi is significant and she can’t catch up, even after doubling contributions.”