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NFB Proficio, a bi-monthly financial update newsletter packed with articles relating to investing, and other issues relevant to our everyday lives and finances.
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NFB FINANCIAL UPDATE
Issue66 February2013
FROM THE CEO’s DESK
Welcome all to 2013, and
congratulations on surviving the End
of the World, as predicted by the
Mayans for December 2012.
However, before we go back into the New Year
celebrating this lucky break, we need to reflect on
the environment both in sunny S.A. and abroad,
from a markets, politic and broad societal
perspective.
2012 was in some cases gentle, in most cases
generous and in a few cases remarkable in
rewarding investors in a broadly bankrupt world,
with broadly inflation beating returns. For those
brave enough to remain or venture into equities,
the local market returned 25%, the balanced funds
which we favour, between 15% and 20%, bonds
delivered a remarkable 16%, given the state of
government's indebtedness, but undoubtedly the
star of the show was listed property, again eclipsing
all comers with a return for the year in the mid
thirties. Lagging well behind the peer group, and
narrowly losing out to inflation was cash, returning a
meager 5% before tax!
The rand, having been somewhat of a global
bully over the last number of years, retreated over
the year, bouncing around and settling weaker
against all comers.
And so on to the year and, indeed, years
ahead. NFB seldom lapse into the predictive
space, although requests to provide investors with
reasonable forecasts are usual and most often
takes pride of position in reviews and when
applying new funds. The art to successful investing
relies rather heavily on a few trump cards. These
include, in no specific order:
! A clear understanding of the investor's goals and
a reduction of these to writing in the form of an
investment objective made measurable through
expression in the form of a benchmark. For
example: an investor's goal might be to have
funds available in retirement, their objective
would be to provide for retirement income
through retirement savings and their benchmark
might be to ensure that their retirement savings
generates a return over meaningful periods (we
would suggest periods between three and seven
years) in excess of inflation;
! A clear understanding of the correlation
between risk and return;
! Defined time lines, i.e. how long the funds can be
deployed without needing to be switched,
loaned against or redeemed;
! Understanding volatility in returns, both between
styles of managers and asset classes;
! Real and after tax returns. Far too often we see
examples of folk being satisfied with a return on a
cash or money fund, which at first blush appears
superior to another fund. However, on reflection,
the other fund delivers dividends, which may
enjoy a far superior after tax return;
! Optimization of tax efficiency. Using products,
wrappers and strategies which look to minimize
the tax and cost drag on returns.
I, and all of the advisory teams at NFB,
continually wrestle with these intertwined issues and
others, in seeking to deliver to clients, each with
their own unique set of circumstances, gratifying
returns. In these times of low yields, crazy volatility in
markets and asset prices, and generally
acceptable returns, the importance of repeatedly
reflecting on these criteria cannot be overstated.
Overseas bonds, particularly investment grade
non-government bonds have enjoyed a great rally.
Whilst other yields still remain much lower, it is
prudent to watch this asset class for signs of
becoming oversold, resulting in the switching of the
funds to lower yielding cash, property or high
dividend paying equities. Parties never go on
forever and typically, the longer they do, and for
the stayers, the risk is big of a serious hangover!
In the local market, as seen in the returns noted
above, our property sector appears more than a
little heated. It must be said that this same
comment could easily have been made a year
ago, but now we are at record highs with little
room for the key players to misfire without triggering
a material sell-off. When confronted with these
tough choices of staying the chase or baling out
into less choppy waters, I tend to believe that if the
unexpected gain already accrued is rather
important in upping your access to income, bank
some. If this is not true, i.e. it is excess to
requirements, then one can choose to stay, brace
everything down and hopefully enjoy the ride.
Turning to matters domestic, we are witnessing
a rather disturbing level of social unrest, particularly
in the Western Cape, perhaps not by fluke, the
home of the DA ruling Provincial Party. The violent
nature of the so-called strike worries me, and when
seeing the levels of intimidation, destruction of
uninvolved property, I run scared. This is not good
for SA Inc. and we need to respect the vast
alternative choices available to investors, both the
very important long term industrialists and property
investors, as well as the more flighty portfolio flows
which have funded our national “overdraft” or
government borrowings. If this was to materially
IN THIS ISSUE
From the CEO’s desk
Inflation and retirement:
the silent killer
f i n a n c i a l s e r v i c e s g r o u pcontinued on the back page...
A new chapter in offshore investingThe Old Mutual
International Investment Portfolio
INFLATION AND RETIREMENT
hile many of us sit and contemplate the reality that
Wwe may have to retire at some point in the future,
statistics show that in reality not many South Africans
can actually afford to retire when that day does
arrive. This is often because of:
not starting to save early enough for retirement
not saving enough during our working careers
using previously saved retirement assets for living expenses
before retirement
poor investment returns
poor financial planning strategies
with increased life expectancies, funds available at retirement
need to provide income for longer periods.
The focus of this article is to illustrate the effects of inflation on
both retirement assets as well as retirement income requirements.
The points mentioned above are a few reasons that can
significantly impact the amount of income that can be drawn
during your retirement years. In many instances, the impact of
inflation on investment returns and the future cash flow that your
retirement portfolio can generate is not well understood, or is
completely ignored. This lack of understanding of the impact of
inflation during retirement can be disastrous as it can result in an
unrealistic expectation as to what type of income a portfolio can
generate and sustain. This in turn lulls investors into a false sense of
security prior to retirement in terms of the amount of money investors
save, and can result in unsustainably high drawings during
retirement.
When reviewing and recommending retirement and investment
products and anticipated investment returns for these vehicles, we
often come across the question of “how much income can an
investment generate, without eroding the capital of the
investment?”. The answer to that question is simple. If one draws at
a rate equal to the return on the investment, the capital value of
the investment will remain intact. There is, however, a massive
problem with this line of thinking in that it doesn't take inflation into
account – and this is one of the biggest problems that a retired
investor faces.
Let's start off by explaining what inflation isWhen we talk about the rate of inflation, this refers to the rate of
inflation based on the consumer price index, or CPI for short. The
South African CPI shows an indexed level of the prices of a standard
“basket” of goods and services which South African households
purchase for consumption. In order to measure inflation, an
assessment is made of how much the CPI has risen in percentage
terms over a given period compared to the CPI in a preceding
period. If prices have fallen this is called deflation (negative
inflation). So if the rate of increase in the CPI is 5%, this means that
the price of the basket of goods and services (as determined by
Stats SA) has increased by 5%. It is important to note that this is
simply a barometer to indicate general price increases in the
economy. One's personal household's inflation will be different from
official CPI and is determined by what that specific household
consumes. In many instances, CPI may in fact understate the rate of
price increases that households experience. For the purpose of this
discussion, we will stick to the official CPI measure.
So why is inflation a problem?We all know that the cost of living increases every year as a result of
increases in things such as food prices, electricity prices, fuel prices,
and the like. Thus it is logical that in retirement, our income needs to
increase in line with inflation to ensure that we can afford to meet
our expenses as they increase every year. And this is where the
problem lies.
If we were to subscribe to the logic of drawing at a level that
equals the rate of return, we would have the same amount of
capital invested at the end of the year. But in reality, the value of
that investment, when adjusted for inflation, has in fact decreased.
Similarly, while the amount of income that is drawn may stay the
same each year, after the effects of inflation are taken into
account, the “real” (or inflation adjusted) value of the income
diminishes year on year. This is illustrated by the example below:
Client age 55
Initial investment R4,000,000
Rate of return 10%
Drawing Rate 10%
Inflation 5%
As can be seen by the two graphs above, while the value of both
the capital and income stay constant (in what we call nominal
terms), the real (or inflation adjusted) value falls year after year. In
this example, the real value of the investment, as well as the real
value of the income that it generates halves in 12 years.
Thus it is clear to see that while at face value, drawing at the
rate of return will protect the capital and income, this is not the case
when inflation is taken into account. Mathematically this is
explained as follows:
Nominal Return 10%
Less: Drawing 10%
= Net Nominal Return 0%
Less: Inflation 5%
= Net Real Return -5%
It is clear then that in order to protect both income and capital
against inflation, it is necessary to draw at a rate that is lower than
the return. In fact, if one wanted to fully protect an investment and
the income it generates against inflation, it is logical to suggest that
the rate of return less the rate of drawing, should be equal to
inflation. Using the same assumptions as above:
Nominal Return 10%
Less: Drawing 5%
= Net Nominal Return 5%
Less: Inflation 5%
= Net Real Return 0%
In this instance, while both the capital and income levels grow from
year to year, when inflation is taken out, the values in real terms stay
constant protecting the client against inflation. Thus the initial
R4,000,000 investment is maintained (in real terms), while the
sustainable income level of R18,000 per month is protected. This
scenario is illustrated below:
What does this tell us:The most important lesson that we learn from all of this is that the
rate of return on our investments is not the same thing as the
sustainable drawing level on the investment. In fact, to determine
the sustainable drawing level of an investment, one needs to take
the expected return and subtract the expected rate of inflation. This
will allow the net growth on the investment to be in line with
inflation, thus protecting the real capital and income levels of the
investment.
If one assumes an expected rate of return is 10%, and inflation
of 5%, a sustainable drawing level is at maximum 5% per annum.
In practical terms, this means that R1,000,000 of capital can
sustainably generate around R50,000 of income per annum. While
this is far lower than many investors would like to believe, it is a
reality that we need to face.
In order to increase this income, one would have to achieve
higher rates of return. To achieve this, higher levels of risk need to be
taken within a portfolio. Investors, however, need to carefully
consider and understand the implications of risk – especially once
retired, as the consequences of capital loss are exacerbated by the
fact that during retirement income is being drawn from the portfolio.
That is to say that if one draws 10%, and the investment loses 15%
(by virtue of being in an aggressive portfolio), the capital value will
be down by 25% in nominal terms, and 30% in real (inflation
adjusted) terms (assuming inflation of 5%). To then get the same
amount of income in rands and cents, the drawing rate has to be
pushed up to around 15% as a result of the lower capital value of
the investment. This scenario can result in massive capital erosion in
a very short space of time.
How much is enoughSo back to the issue of “how much do I need to retire?”.
Unfortunately, there is no universal answer to this question, as it is
specific to one's personal circumstances and needs, and is reliant
on uncertain factors such as expected rates of return, and future
inflation rates.
While the discussion above is sobering, it does, however,
empower us with knowledge that we can apply, in that it informs us
of what a sustainable drawing rate is. So when answering the “how
much is enough” question, we need to consider some of the
following factors:
What is the value of your current investable assets?
How much does one contribute to these assets on a monthly
basis?
How much income do you need in retirement to meet your
monthly requirements?
What are the current and expected rates of return on the
portfolio?
What is the expected level of inflation?
Prior to retirement these questions can help investors with
decisions around savings rates, the risk profile of their investments, as
well as around managing their expense levels more effectively so
that at retirement, their expenses and sustainable income are
commensurate.
When closer to retirement, understanding the impact of inflation
on capital and drawings can help investors carefully consider the
level of drawing they select to ensure that their savings are
managed in such a way as to provide income sustainably into the
future.
Retirement planning and the impact of inflation are vitally
important aspects of financial planning. We strongly suggest that
you discuss these issues with your NFB advisor.
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INFLATION AND RETIREMENT
The effects of inflation on both retirement assets as well as
retirement income requirements. By Andrew Duvenage &
Grant Magid, NFB Gauteng, Private Wealth Managers
THE SILENT KILLER
INFLATION AND RETIREMENT
hile many of us sit and contemplate the reality that
Wwe may have to retire at some point in the future,
statistics show that in reality not many South Africans
can actually afford to retire when that day does
arrive. This is often because of:
not starting to save early enough for retirement
not saving enough during our working careers
using previously saved retirement assets for living expenses
before retirement
poor investment returns
poor financial planning strategies
with increased life expectancies, funds available at retirement
need to provide income for longer periods.
The focus of this article is to illustrate the effects of inflation on
both retirement assets as well as retirement income requirements.
The points mentioned above are a few reasons that can
significantly impact the amount of income that can be drawn
during your retirement years. In many instances, the impact of
inflation on investment returns and the future cash flow that your
retirement portfolio can generate is not well understood, or is
completely ignored. This lack of understanding of the impact of
inflation during retirement can be disastrous as it can result in an
unrealistic expectation as to what type of income a portfolio can
generate and sustain. This in turn lulls investors into a false sense of
security prior to retirement in terms of the amount of money investors
save, and can result in unsustainably high drawings during
retirement.
When reviewing and recommending retirement and investment
products and anticipated investment returns for these vehicles, we
often come across the question of “how much income can an
investment generate, without eroding the capital of the
investment?”. The answer to that question is simple. If one draws at
a rate equal to the return on the investment, the capital value of
the investment will remain intact. There is, however, a massive
problem with this line of thinking in that it doesn't take inflation into
account – and this is one of the biggest problems that a retired
investor faces.
Let's start off by explaining what inflation isWhen we talk about the rate of inflation, this refers to the rate of
inflation based on the consumer price index, or CPI for short. The
South African CPI shows an indexed level of the prices of a standard
“basket” of goods and services which South African households
purchase for consumption. In order to measure inflation, an
assessment is made of how much the CPI has risen in percentage
terms over a given period compared to the CPI in a preceding
period. If prices have fallen this is called deflation (negative
inflation). So if the rate of increase in the CPI is 5%, this means that
the price of the basket of goods and services (as determined by
Stats SA) has increased by 5%. It is important to note that this is
simply a barometer to indicate general price increases in the
economy. One's personal household's inflation will be different from
official CPI and is determined by what that specific household
consumes. In many instances, CPI may in fact understate the rate of
price increases that households experience. For the purpose of this
discussion, we will stick to the official CPI measure.
So why is inflation a problem?We all know that the cost of living increases every year as a result of
increases in things such as food prices, electricity prices, fuel prices,
and the like. Thus it is logical that in retirement, our income needs to
increase in line with inflation to ensure that we can afford to meet
our expenses as they increase every year. And this is where the
problem lies.
If we were to subscribe to the logic of drawing at a level that
equals the rate of return, we would have the same amount of
capital invested at the end of the year. But in reality, the value of
that investment, when adjusted for inflation, has in fact decreased.
Similarly, while the amount of income that is drawn may stay the
same each year, after the effects of inflation are taken into
account, the “real” (or inflation adjusted) value of the income
diminishes year on year. This is illustrated by the example below:
Client age 55
Initial investment R4,000,000
Rate of return 10%
Drawing Rate 10%
Inflation 5%
As can be seen by the two graphs above, while the value of both
the capital and income stay constant (in what we call nominal
terms), the real (or inflation adjusted) value falls year after year. In
this example, the real value of the investment, as well as the real
value of the income that it generates halves in 12 years.
Thus it is clear to see that while at face value, drawing at the
rate of return will protect the capital and income, this is not the case
when inflation is taken into account. Mathematically this is
explained as follows:
Nominal Return 10%
Less: Drawing 10%
= Net Nominal Return 0%
Less: Inflation 5%
= Net Real Return -5%
It is clear then that in order to protect both income and capital
against inflation, it is necessary to draw at a rate that is lower than
the return. In fact, if one wanted to fully protect an investment and
the income it generates against inflation, it is logical to suggest that
the rate of return less the rate of drawing, should be equal to
inflation. Using the same assumptions as above:
Nominal Return 10%
Less: Drawing 5%
= Net Nominal Return 5%
Less: Inflation 5%
= Net Real Return 0%
In this instance, while both the capital and income levels grow from
year to year, when inflation is taken out, the values in real terms stay
constant protecting the client against inflation. Thus the initial
R4,000,000 investment is maintained (in real terms), while the
sustainable income level of R18,000 per month is protected. This
scenario is illustrated below:
What does this tell us:The most important lesson that we learn from all of this is that the
rate of return on our investments is not the same thing as the
sustainable drawing level on the investment. In fact, to determine
the sustainable drawing level of an investment, one needs to take
the expected return and subtract the expected rate of inflation. This
will allow the net growth on the investment to be in line with
inflation, thus protecting the real capital and income levels of the
investment.
If one assumes an expected rate of return is 10%, and inflation
of 5%, a sustainable drawing level is at maximum 5% per annum.
In practical terms, this means that R1,000,000 of capital can
sustainably generate around R50,000 of income per annum. While
this is far lower than many investors would like to believe, it is a
reality that we need to face.
In order to increase this income, one would have to achieve
higher rates of return. To achieve this, higher levels of risk need to be
taken within a portfolio. Investors, however, need to carefully
consider and understand the implications of risk – especially once
retired, as the consequences of capital loss are exacerbated by the
fact that during retirement income is being drawn from the portfolio.
That is to say that if one draws 10%, and the investment loses 15%
(by virtue of being in an aggressive portfolio), the capital value will
be down by 25% in nominal terms, and 30% in real (inflation
adjusted) terms (assuming inflation of 5%). To then get the same
amount of income in rands and cents, the drawing rate has to be
pushed up to around 15% as a result of the lower capital value of
the investment. This scenario can result in massive capital erosion in
a very short space of time.
How much is enoughSo back to the issue of “how much do I need to retire?”.
Unfortunately, there is no universal answer to this question, as it is
specific to one's personal circumstances and needs, and is reliant
on uncertain factors such as expected rates of return, and future
inflation rates.
While the discussion above is sobering, it does, however,
empower us with knowledge that we can apply, in that it informs us
of what a sustainable drawing rate is. So when answering the “how
much is enough” question, we need to consider some of the
following factors:
What is the value of your current investable assets?
How much does one contribute to these assets on a monthly
basis?
How much income do you need in retirement to meet your
monthly requirements?
What are the current and expected rates of return on the
portfolio?
What is the expected level of inflation?
Prior to retirement these questions can help investors with
decisions around savings rates, the risk profile of their investments, as
well as around managing their expense levels more effectively so
that at retirement, their expenses and sustainable income are
commensurate.
When closer to retirement, understanding the impact of inflation
on capital and drawings can help investors carefully consider the
level of drawing they select to ensure that their savings are
managed in such a way as to provide income sustainably into the
future.
Retirement planning and the impact of inflation are vitally
important aspects of financial planning. We strongly suggest that
you discuss these issues with your NFB advisor.
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dit: 1
23
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to
INFLATION AND RETIREMENT
The effects of inflation on both retirement assets as well as
retirement income requirements. By Andrew Duvenage &
Grant Magid, NFB Gauteng, Private Wealth Managers
THE SILENT KILLER
A NEW CHAPTER IN OFFSHORE INVESTING
A licensed Financial Services Provider
Johannesburg Office:
NFB House 108 Albertyn Avenue Wierda Valley 2192,
P O Box 32462 Braamfontein 2017, Tel: (011) 895-8000 Fax: (011) 784-8831
E-mail: nfb@nfb.co.zaWeb: www.nfbfinancialservicesgroup.co.za
East London Office:
NFB House 42 Beach Road Nahoon East London 5241, P O Box 8132 Nahoon 5210,
Tel: (043) 735-2000 Fax: (043) 735-2001E-mail: info@nfbel.co.zaWeb: www.nfbec.co.za
Port Elizabeth Office:
110 Park Drive Central Port Elizabeth 6001, P O Box 12018 Centrahil 6001,
Tel: (041) 582-3990 Fax: (041) 586-0053E-mail: info@nfbpe.co.za Web: www.nfbec.co.za
As funds with foreign exposure start to outperform their domestic
counterparts, and economists warn that domestic markets are
overpriced, investors seeking maximum returns are starting to test
foreign waters again. Old Mutual International has responded by
offering a new product, called the Investment Portfolio, which offers
incomparable benefits.
ONE WRAPPER FOR ALL YOUR ASSETSThe product itself is a life wrapper designed to hold offshore assets
such as share portfolios, unit trusts, exchange-traded funds, currency
accounts and structured notes. There are a number of benefits for
using the wrapper, the most impressive being tax efficiency.
TAX-FREE RETURNSMost products that were previously used for offshore investment
involved the appointment of the contract holder/s as lives assured
under the policy, and company tax rates (currently 30%) were
applied to all returns. The Investment Portfolio is structured so that it
does not have lives assured and there is no tax in South Africa in
respect of returns earned. Buying and selling assets within the
portfolio will not attract a Capital Gains Tax liability, and the final
proceeds received on redemption of the contract will be tax-free,
provided they are received by the original beneficial owner of the
policy.
ESTATE PLANNINGBecause there are no lives assured, the investment will not
automatically come to an end upon death of the contract holder.
The investment can continue for up to 99 years unless it is fully
surrendered by the contract holder, or by his/her executors
following death. You can also nominate beneficiaries to whom the
contract will be transferred upon death, rather than to your estate,
and this will avoid probate, reduce delays and costs in wrapping up
your estate, and gives you the assurance of knowing what will
happen with the investment. In the past, many investors have seen
fit to appoint offshore trusts in order to carry out their wishes in terms
of their offshore portfolios after their passing. This can be a costly
and time consuming task, and the Investment Portfolio takes care of
this.
RESTRICTIONSThe only drawback is that only a restricted amount may be
withdrawn within the first five years of investment. This is a small price
to pay considering that offshore investing should only be
undertaken with a long term view of five years or more.
In essence, the Investment Portfolio is a simpler and more efficient
product for offshore investment than has been offered in the past. It
allows you to combine a number of different assets within one
portfolio and lifts the burden of administration and reporting from
your hands. In addition, the fact that your returns are not reduced
by income tax ensures that you will benefit from the maximum
returns possible.
After a decade of disappointing returns,
offshore investing is once again in the spotlight.
By Mikayla Collins, NFB Western Cape, Private
Wealth Manager
A NEW CHAPTER IN OFFSHORE INVESTING
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to
slow down, never mind reverse, we could witness a dramatic
weakening of our currency. This in itself is a double-edged sword,
aiding the efforts of our industrial, mining, commodity and tourism
sectors, but bedeviling the borrowing costs of the government as it
strives to inject capital into the development of infrastructure and
our broader budget spend. Of critical importance is the delivery of
services and improved standards of living to the broader
population. Suggestions that these people should look after
themselves is a non-starter as they haven't got a dog's chance of
even getting into the game. They need a hand up, and in South
Africa, as is the case around the world, this is where it starts from.
One agrees that a successful state is not created by taking from
the rich to sort out the poor, but if we are to avoid the risks faced in
the north of our continent over the last year or two, we need to take
ownership of these issues. They will not go away by us denying they
exist. I have listened to leaders in politics and business debating
these issues and it is somewhat reassuring that they are enjoying lots
of attention, although as is often the case, this positive news doesn't
sell newspapers and is therefore not aired publically. I must say that
Mr Ramaphosa being elected into the number two seat in the ANC
makes me happier. He enjoys popular support, has a sound
following beyond our borders and certainly knows his way around
business South Africa and beyond. Every cloud………..
To all of our clients and supporting peers in the life of NFB we
wish you well for the year ahead. As one wag was reported to have
twittered, one day before the Mayan Doomsday, “my wife got us
tickets to The Nutcracker for tomorrow night, so at this point I'm
rooting for the Mayans”.
Thank you for your continued support.
®Mike Estment, BA CFP
CEO, NFB Financial Services Group
FROM THE CEO’s DESK continued from page one...
THE OLD MUTUAL INTERNATIONAL INVESTMENT PORTFOLIO
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