Old Mutual Corporate: South Africa Retirement Sequence of Returns Risk Slashes Income by 30%

• Sequence-of-returns risk can dramatically alter retirement outcomes, as demonstrated by two savers with identical contributions but vastly different final sums.
• One saver had R3.95 million by March 2020, while another had R3.11 million, leading to a nearly 30% difference in monthly retirement income.
• Marvin Nair of Old Mutual Corporate highlighted how retiring during a market crash, like that of March 2020, can severely impact lifelong income.
• Smoothed bonus products aim to mitigate this risk by buffering market volatility, though some experts question their value given market trends.
• The timing of market performance around retirement, not just total returns, is crucial for financial security in later life.

This phenomenon, known as sequence-of-returns risk, underscores how the timing of market performance, particularly around retirement, can profoundly dictate an individual's financial security for decades.

The precise timing of one's retirement, particularly in relation to market volatility, can dramatically alter financial outcomes, a phenomenon known as sequence-of-returns risk. This critical issue for South Africa retirement planning was highlighted by Marvin Nair, an investment solutions executive at Old Mutual Corporate, during a recent Institute of Retirement Funds Africa (Irfa) conference. He presented a compelling scenario involving two individuals who began saving R10,000 monthly from April 2007, increasing contributions by 4.5% annually, with no early withdrawals. Both aimed for funds targeting returns of at least CPI plus 5% per year, a common benchmark.

Despite identical savings patterns, by March 2020, one saver had accumulated R3.95 million, while the other held R3.11 million – a significant 27% difference. Both retired that month, coinciding with the market crash triggered by the Covid-19 pandemic. This divergence led to vastly different retirement incomes: assuming identical annuity rates, one received R10,000 per month from a life annuity, while the other received only R7,300. This represents a nearly 30% reduction in their anticipated standard of living, underscoring the severe impact of a retirement fund market crash impact ZA.

Nair further illustrated this risk with a second example involving living annuities. Two investors each started with R5 million in 2007, withdrawing R30,000 monthly, increasing by 4.5% annually. After 19 years, the investor utilizing a risk-managed solution retained R11.5 million, whereas the investor in a non-risk-managed portfolio had only R3.7 million remaining. This stark difference of over 200% demonstrates how inadequate living annuity risk management South Africa can jeopardize long-term financial security, potentially leading to retirees outliving their savings.

Sequence-of-returns risk specifically refers to the order in which investment returns occur, which can have a profound impact on retirement outcomes once withdrawals commence. Unlike the overall average return, the timing of negative returns, especially early in retirement, can deplete capital much faster, leaving less to recover during subsequent market upturns. This risk is particularly acute for individuals invested in market-linked balanced funds, which typically hold a mix of bonds, equities, and listed property, as these can experience substantial capital losses during market downturns precisely when retirees begin drawing income.

As Nair pointed out, retirement dates are largely determined by birth dates, meaning individuals often have little control over when they enter retirement. This lack of control over timing, coupled with the potential for market crashes, exposes retirees to significant financial vulnerability. The examples provided, though based on a 13-year horizon to align with data from the Old Mutual AGP Smooth product launched in 2007, effectively highlight the long-term consequences of retiring into an adverse market environment.

One proposed solution to mitigate the South Africa retirement sequence of returns risk is the use of smoothed bonus products South Africa. Nair explained that these products involve an insurer investing in a similar asset mix to a balanced fund but declaring periodic bonuses (monthly or annually) based on a reserve. The mechanism involves holding back some returns during strong market periods to support bonuses during weaker periods, aiming to reduce the 'bumpy ride' of market volatility and provide a more consistent return profile. Nair argued that while market-linked investments might offer superior outcomes during favorable periods, they can lead to 'terrible outcomes' during downturns, suggesting that a smoothed bonus portfolio delivers a 'better average outcome to all members.'

However, this approach is not without its critics. Casparus Treurnicht, a portfolio manager at Gryphon Asset Management, questioned the rationale behind smoothed bonus products. Citing total-return data from the JSE All Share Index and the MSCI World Index from 1998 to 2026, Treurnicht noted that the equity market typically rises in 65% of those years. He argued that focusing on mitigating the 35% likelihood of market lows through smoothing also reduces or smooths out the 65% of market highs, which he found counterintuitive. His perspective challenges whether the trade-off in potential upside is justified by the reduction in downside volatility.

The profound impact of sequence-of-returns risk on individual retirement outcomes underscores a critical responsibility for retirement fund fiduciaries and financial advisors in South Africa. They must possess a deep understanding of this risk and actively implement strategies to mitigate its effects. Providing appropriate advice on retirement product choices, particularly concerning living annuity risk management South Africa and the suitability of smoothed bonus products, is paramount to fulfilling their fiduciary duties.

The dramatic divergence in retirement incomes and capital preservation highlighted by the examples serves as a stark reminder of the potential for significant negative impacts on individuals' financial well-being. Ensuring that members are adequately protected from market timing risks, especially as they approach and enter retirement, is not merely a matter of good practice but a fundamental requirement for safeguarding the financial future of South African retirees.

This article highlights a critical financial risk that retirement fund fiduciaries and financial advisors in South Africa must address. They need to understand and mitigate 'sequence-of-returns risk' to fulfill their fiduciary duties and ensure clients receive appropriate advice on retirement product choices, especially given the potential for significant negative impacts on retirement income and ongoing regulatory scrutiny of fund performance.

Source: Insights derived from a presentation at the Irfa conference.