Every individual must go through three distinct phases in their financial lives.
A dependant phase is typically at the beginning and end of one’s natural life. The first dependant phase is hard to escape as one is a minor and must develop into a space where they can fend for themselves.
The second one, however, can be viewed as a choice. The second phase is the accumulation phase, where one toils and amasses wealth, and the third a decumulation phase, where one typically is not in active employment and lives off the wealth gained in their accumulation phase. Whichever stage in your life you may be, adequate preparation for the quality of life you want to live when you can no longer work will be critical to your state of mind, relationships and more importantly your mental and physical health.
At the base of every retirement dream, there should be a holistic approach to investment. This is why. If the goal is to live a comfortable life in your golden years, then your retirement account should form a portion of your financial plan and not the entirety of it.
To put this into context, a robust financial plan as your financial adviser will tell you should have at the bare minimum, short-term, medium-term and long-term cohorts. These will vary, of course, across the different life stages.
A 25-year-old and a 45-year-old probably have different ideas of what they would want to achieve in the next one to five years of their lives. For the latter, retirement at that time is a more probable proposition than it would be for the former.
If we picked a 32-year-old ardent investor for example, and dissected their personal portfolio, then we could find a money market account, sub-360-day paper, and a liquid mutual fund in the short-term cohort, an 8-year bond, a balanced fund and a growth fund with a good wealth manager in the medium term cohort and a REIT (real estate investment trust), a good stocks portfolio, a 20-year infrastructure bond and finally their retirement account in the long-term cohort.
This individual would have organised their finances in such a way that they can meet their obligations as and when they fall due, putting him in a healthy position to not only eventually retire, but retire well.
A wise man once said, “The enemy of your future revenue is your current revenue” to that I say, the enemy of your future revenue is also your current expenditure. One cannot expect to build a lasting nest egg sometime in their future if they cannot keep at bay the obligations that keep falling due as they journey through their life.
They would inevitably keep on taking from their nest egg to fund their immediate needs. A good example of this in Kenya is when an employee transitions from one employer to another and keeps on withdrawing 50 percent of their accumulated retirement savings thereby effectively robbing their future self of a good portion of their income.
At the point of permanently finishing with gainful employment, retirement funds would typically allow you to access your funds in two different ways depending on whether you were in a pension fund or a provident fund.
In a pension fund, up to a third of your retirement pot is accessible immediately and two-thirds of the same pot is mandated to go towards a post-retirement product.
On the flip side a provident fund allows one to withdraw their corpus in totality, net of applicable tax, putting the burden of planning for retirement squarely on their shoulders. Whether or not you have other sources of income apart from the income that comes from the retirement pot will be important in choosing how to structure your retirement from a financial point of view. One does tend to put more away in these products if they have other sources of income.
From a risk management point of view, the more you put away in exchange for regular income in retirement, the less the risk of running out of money before your demise. This is an essential component of your decumulation phase, as it determines whether you will sign off in control of your life, or as a burden to the rest of your family members.
Depending on where you come from, outliving your retirement income is the chief determinant of whether you will have lived a dignified life in retirement or not.
In this territory the post-retirement product options are three-fold; an annuity, and income drawdown or a combination of the two. As I earlier stated, the amount of money one puts away in these products is a direct subset of their financial position at the beginning of their retirement journey.
For the individual with singular income i.e. their retirement pot alone, then an annuity contract would make sense depending on how much this income is relative to their net replacement ratio (the pension in hand in relation to the person's own last wage, from which taxes and contributions have been deducted).
At the base, they would be assured of periodic income for the rest of their natural lives. However, should the individual not replace enough of their income, then that would assure them of a life in retirement awash with struggle.
On the other end of the spectrum, the individual with multiple streams of income would have more options, where they may choose to have their retirement pot managed by an IDD fund, thereby shouldering the investment risk that comes with such plans and equally maximising their chances to make an income in their retirement.
The latter individual, therefore, has a better chance of actually adding to their net worth in their decumulation phase thereby ensuring they can transfer their assets or portfolio to the next generation. The good book after all dictates, that a good man leaves an inheritance to his children’s children.
I would suggest that you be the Financial Director of your life. Take stock of your finances, evaluate where you may come up short, and craft ways in which you may bridge the gap to financial freedom.
The writer is a consultant on retirement solutions. He can be reached via [email protected]
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