Financial security is vital in retirement, but having enough money does not in itself guarantee that you will be content. At this year’s Alexander Forbes/Personal Finance Ready Set Retire conference, John Anderson, the head of research and product development at Alexander Forbes, discussed the relationship between money and happiness.
Having enough money is not the only factor that will determine whether you are fulfilled during retirement, John Anderson says.
In addition to being financially secure, contentment in retirement will depend on your lifestyle, how well you prepare emotionally for the changes that retirement will bring and what you do with your time.
Anderson says it is important that you have a fulfilling retirement, not just lots of money.
“A lot of people put too much emphasis on the financial aspects of retirement,” he says.
“Everyone’s needs in retirement are different; your needs are specific to you. You need to decide on all your needs and objectives for retirement before you actually retire.”
At the same time, he says, you should be concerned about your financial security. Historically, a savings target for retirement has been a pension of between 60 and 75 percent of your final salary.
However, South African research indicates that you will probably need an income in retirement of more than 80 percent of your final salary. And, depending on your standard of living, even 90 percent may not be enough.
Once you retire, you may spend less on some things, such as transport to and from work, but you will spend more on others, such as health care, where costs are increasing by two or three percentage points above inflation every year.
But having sufficient money in retirement will not necessarily buy you happiness.
Anderson says international research has found that the United States has the world’s highest income per head of population, but it does not have the longest life expectancy. This shows that money does not explain everything.
He says that, even in developed countries, a high level of income inequality results in more social and health problems. This is also true of South Africa, which is one of the most unequal societies in the world. A consequence of inequality is that middle- and low-income people live beyond their means, because they spend money on luxuries for aspirational reasons and to achieve instant gratification.
We often spend more on things we do not need than on the essentials – for example, a big-screen TV and a DStv subscription instead of good food and health care.
Anderson says that, in retirement, it is important to prioritise your spending according to your needs and financial resources.
He says you should interrogate your motives for wanting to buy something and distinguish between luxuries and necessities.
Anderson says a good way to achieve contentment and financial stability before and during retirement is to base your spending on Maslow’s hierarchy of needs, which is a theory of human motivation proposed by US psychologist Abraham Maslow in 1943.
The hierarchy of needs is often portrayed in the shape of a pyramid with the largest, most fundamental levels of needs at the bottom and the need for self-actualisation (the need to be good, to be fully alive and to find meaning in life) at the top.
In designing your budget, you need to start at the lowest tier of the pyramid and work your way up.
Anderson says the five tiers of the pyramid are:
1. Physical needs: Your first priority is to have food, accommodation and access to basic health care.
2. Safety: You must be able to protect yourself, your assets and your income. This requires spending on, among other things, homeowner’s insurance and medical scheme cover, and having enough savings to provide a basic level of income if you live longer than expected.
3. Belonging: We have a need to belong to a social group, such as a family or a community that shares our beliefs or interests. At this level of the hierarchy, you spend on other people, such as your family, and on entertainment and luxuries.
4. Esteem: We want to be valued by others. This may involve spending on things that make you feel good about yourself, such as hobbies and sport.
5. Self-actualisation: This may require spending on philanthropic causes, to help those in need.
Anderson says many people do not live according to this hierarchy, because living in an unequal society has a psychological impact on spending habits. For example, retirees may not eat nutritious food, but they avidly watch television or spend money on things that satisfy higher-level needs. Ideally, they should focus on meeting their lower-level needs first.
Anderson says how you spend your money in retirement will determine your happiness. “Having more money does not mean you will have a happier retirement. You can be happier with less,” he says.
He says examples of how you can maximise your happiness through your spending patterns are:
* Instead of buying one big luxury item once, you will derive more satisfaction if you spend on small luxuries more often.
* Regularly spend small amounts on people such as your grandchildren, instead of buying them expensive gifts only once or twice a year.
* Take advantage of experiences that cost very little or nothing, such as hiking or going on a picnic with your grandchildren. Experiences are more satisfying than things, because the memories last longer and have more meaning.
* Delay purchases. The anticipation will increase the enjoyment and postpone spending.
Anderson says wise spending based on a hierarchy of needs is essential for most pensioners, because they did not prepare financially for retirement.
POST-RETIREMENT INVESTMENT STRATEGY IS KEY TO INCOME
Your retirement savings should provide you with a stable monthly income that will enable you to maintain your standard of living throughout your retirement, John Anderson says.
The value of your investments should not fluctuate wildly, nor should your investments gradually lose value because they cannot keep pace with inflation. If this does happen, the purchasing power of your income will decrease every year.
Anderson says selecting an appropriate investment strategy in retirement is as important as, if not more important than, the strategy you use when you save for retirement.
Of every one rand you spend in retirement, 23 cents will come from your retirement fund contributions, 36 cents will come from pre-retirement investment returns and 41 cents should come from post-retirement investment returns.
Anderson says that how you choose to convert your savings into an income (annuity) at retirement is crucial to the pension you will receive. For example, if you have R1 million to buy a guaranteed annuity, the pension you receive will vary significantly, depending on when you buy it. If you bought a pension in August 2007, you would have received an initial monthly income of R3 753. If you had bought it when the global financial crisis started in 2009, you would have received R3 250. Currently, you would receive R3 203, because central banks have kept interest rates low in an attempt to promote economic growth.
It is difficult and often expensive to transfer out of a guaranteed annuity. You could phase your retirement savings into a guaranteed annuity or postpone buying one until interest rates rise. In the meantime, you could buy an investment-linked living annuity, where you take the risk that your retirement savings will last until you die.
Living annuities are more popular than guaranteed annuities; 80 percent of retirees use them.
The potential pitfalls of a living annuity are adopting an inappropriate investment strategy and drawing down an income that is too high. This has resulted in some pensioners running out of money within seven years of retirement. Anderson says that, in most cases, you should not draw down more than four percent of your annual capital value.
The biggest investment mistake is switching in and out of asset classes as the markets rise or fall, Anderson says. Typically, people invest in equities when prices are already peaking. When the market turns, they panic, disinvest and put their cash in money market funds. As a result, they permanently destroy wealth, whereas they would have recovered their losses if they had remained invested in equities, because they would have benefited when prices started to rise, he says.
Anderson says Alexander Forbes has developed the Sorri ratio, which calculates the probability that you may be “sorri” in retirement. Sorri stands for the “shortage of required retirement income” and is used to calculate the likelihood of different investment strategies providing an income sufficient to cover basic expenditure and providing an income that will enable you to live in some comfort. For example, you may have an almost 100-percent probability of a basic income, but only a 40-percent chance of having an income that will provide a comfortable income.