How compound growth transforms small retirement annuity contributions into big retirement outcomes

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The power of compound interest should never be underestimated, especially when it comes to retirement annuities. Compound interest is a tool that can be leveraged to great effect, and has the potential to amplify the long-term outcome of your retirement annuity investments.  

Even modest contributions, made regularly over many years, can grow significantly as returns start generating their own returns. With the right amount of time and under the right conditions, small, consistent investments can turn into a substantial amount for retirement.  

This article looks at the importance of regular contributions over the long term and how compound growth can lead to big retirement outcomes, most notably in a low-cost, tax-efficient vehicle like a 10X retirement annuity.  

What is compound growth?  

Compound growth is a powerful force that can significantly boost your savings over time. It doesn’t just apply to your initial investment; it also builds on the growth and interest that your money has already earned, creating a snowball effect as time passes.   

Each year, the returns from your retirement annuity are reinvested, allowing your capital to generate growth on both the original investment and the returns already earned. The sooner you start contributing, the more time your money has to compound, and the greater the retirement outcome you’ll receive. In other words, the longer your RA compounds, the more potential growth there will be, and the more profound the influence of compounding growth will be.  

What are retirement annuities, and why are they built for compounding?  

Retirement annuities are long-term, tax-efficient retirement savings vehicles that allow you to save for your retirement years. Contributions to retirement annuities are tax-deductible, subject to annual limits. These are up to 27.5% of your income or R350 000.  

Any tax refunds from SARS or money that you can save due to tax deductions should ideally be reinvested in your RA, as this can further boost the effect of compound growth. Investment returns within the RA are exempt from income tax, dividends tax and capital gains tax while invested.  

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RAs are an excellent solution for those without a company pension fund, providing an effective way to save for retirement. Setting up a monthly debit order that comes off your account at the beginning of the month makes it easy to contribute regularly without relying too heavily on self-discipline. Regular contributions give your investment more time to grow and benefit from compounding, an advantage that becomes even more significant by the time you retire.   

How to maximise compound growth  

Compound growth works best when given enough time and the right conditions. In this section, we’ll take a brief look at how you can maximise compound growth, before diving deeper into each factor.   

Start early  

The most important tip is to start early. The sooner you start contributing to an RA, the more time your money has to grow and potentially compound over time. Even small contributions made in your 20s and 30s can end up being worth more than larger contributions made later in life, as compounding would have had more years to work in your favour.  

Contribute regularly  

Making sure you regularly contribute is more important than the size of the contributions in the beginning. A steady monthly debit order can add to your RA monthly, giving compounding more to work with. Increasing your contributions over time will also further pronounce this effect. 

Understand asset allocation  

It’s not just about regular contributions, though; it’s also about where you invest. With the right mix of assets in your RA, you can balance risk and return in a way that maximises your RA’s growth potential over the years.  

Control costs  

If you’re paying high fees, this can reduce the compounding effect. As such, choosing a low-cost service provider means more of your money stays invested and can potentially compound and grow over time. A small difference in fees can make a major difference in retirement outcomes.  

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The power of starting small and early 

When starting your RA, a regular monthly debit order of just R500 or R1000 is considered good enough. Often, people delay starting because they feel their contributions are too small, but the most important step is just to get started. Getting started early and staying consistent can lead to major results.  

You can increase your monthly contributions when your financial circumstances allow for it, such as when you get a salary increase. You will need to check the minimum debit order and/or lump sum amounts allowed by your particular service provider to make sure that you are above this minimum amount.  

Let’s look at an example to illustrate the profound effect of compound growth: 

Scenario 1: You decide to invest a R100k lump sum and generate 6% real return over 30 years.  

Scenario 2: You decide to invest a R100k lump sum, and also include a debit order of R1000 per month for 30 years, which also generates a 6% real return.  

In Scenario 1, you end up with approximately R482,000. 

In Scenario 2, you end up with approximately R1.5 million.  

Even a small, regular debit can grow significantly when compounded over 30 years, which could make a meaningful difference to the amount you have available for retirement. Increasing your monthly contributions over time can also drive compound growth even more. This example is for illustrative purposes only, and actual results may vary. 

A deeper look at asset allocation  

Choosing your asset allocation carefully is key to getting the most out of your RA contributions. Your savings are typically invested across a range of assets, including equities, bonds, property and cash, with options for offshore investments, too. The right mix of assets depends on your investor profile, taking into account your comfort with risk and market volatility, as well as your time horizon.  

As an investor with 10X, you’ll have the freedom to adjust your underlying portfolio by selecting from a range of carefully curated RA funds, each with a different mix of assets, geared towards different investor profiles. A well-structured asset allocation can help your contributions work harder over the long term and potentially generate the returns that you’re aiming for.  

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Generally, equities may produce the best returns over the long run, but they are also the most volatile of the asset classes. Equities have historically produced returns above inflation by around 7% annually over the long term (based on JSE All Share Index performance versus CPI from 1960-2020); however, past performance does not guarantee future results.  Bonds are more stable but likely to produce lower returns compared to equities, while real estate is often a good hedge against inflation. Cash is very stable but also likely to produce the lowest returns of the asset classes. Including a mix of different asset classes allows for diversification. You can take advantage of the different economic cycles and see the gains in certain asset classes while also mitigating against losses in other asset classes.  

Diversifying offshore allows you to take advantage of opportunities that the international market has on offer. The international market is much bigger than the local South African market, offering more opportunities in terms of different industries and companies to invest in. Diversifying offshore can also be a powerful hedge against any local market instability and potential depreciation of the rand.  

Retirement annuities are subject to Regulation 28 of the Pension Funds Act, and these limits must be adhered to. This regulation limits the amount of your retirement annuity that you may invest in both equities and offshore. Currently, the cap is at 45% for offshore investments and 75% allocation to equities. This act was implemented to help protect investors against poorly diversified portfolios.  

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10X understands the importance of asset allocation and meeting your long-term investment and retirement goals. With this in mind, we offer a wide range of strategically picked funds that you can invest in within the retirement annuity wrapper. Each of these funds has been structured to suit different investor profiles. No matter your circumstances, there will be a fund to suit your particular financial situation and goals. To find out more about the funds on offer at 10X, click here.  

How fees erode compound growth 

Higher fees may have the potential to erode returns, especially when compounded over the long term. High fees mean fewer available returns to reinvest and potentially grow over time. Here, we’re essentially seeing an example of reverse compounding, where the compounding is now working against us and not for us. On the other hand, lower fees mean more returns are available to be reinvested and potentially compound over time, helping you reach your retirement goals.  

You should always be aware of the fees that you’re being charged on your retirement annuity. If you find them to be on the higher side, you may wish to explore other provider options, so you can properly take advantage of potential compound growth. The typical fees which you may see charged on your RA are the following: 

Administration fees: These are the fees charged for all administration-related tasks, such as compliance, tax and reporting.  

Advisor fees: These are the fees which you would see charged by an advisor for their financial guidance. There is usually both an initial and an ongoing fee charged.  

Management fees: These are the fees charged for the overall management of the fund. 

Let’s look at an example to illustrate the effect of fees of 3% versus fees of 1%: 

We will assume the following factors: 

Investment period of 30 years 

Initial lump sum investment of R50,000 

Monthly contributions of R2000 

Return of 12% per annum 

An inflation rate of 6% 

Example 1 (1% Fees): Real investment value is approximately R1.8 million 

Example 2 (3% Fees): Real investment value is approximately R1.3 million 

We can see how just a 2% difference in fees can have a substantial impact on the savings that you have available to you at retirement. This example is for illustrative purposes only, and actual results may vary. Learn more about fees here.  

Reviewing your Effective Annual Cost (EAC) is a great way to make sure you’re aware of all the fees being charged. The EAC is the total cost and fees of owning an investment over a one-year period of time. This metric was introduced by ASISA in 2015 and includes all costs for the year. This includes administration fees, advisor fees, management fees and any other applicable fees. You can find your RA’s EAC on your RA statement.  

All things being equal, you may see that a higher EAC would result in fewer returns being available for reinvestment compared to a lower EAC, which may mean there are more returns available to be reinvested and potentially compound over time. The EAC is just one factor to consider when comparing service providers. 10X offers a free EAC calculator as a part of our online suite of tools available on our website. This allows you to compare the fees charged by 10X with those fees charged by your service provider.  

Even if you start your RA off with small, regular contributions, this can potentially impact the growth of your RA over time, especially when you also make use of a low-cost service provider. 10X has a transparent and low fee structure, typically charging fees of 1% or less for most of our retirement products. Fees charged will, however, depend on the product selected and the amount invested. We make use of an index tracking investment strategy with a more active approach to asset allocation, focusing on excellent long-term returns for our clients.  

Final thoughts on compound growth in retirement annuities   

Taking advantage of the investing tools you have, such as time, consistency, asset allocation, and low fees, can mean that your small contributions to an RA result in more capital available for you for your retirement years.  

If you haven’t yet started contributing to an RA, now is the time to set up a monthly debit order, a great way to maintain contributions without relying heavily on self-discipline. 10X’s low-cost and transparent RA is an excellent place to start.  

To find out more about the 10X retirement annuity, follow this link or speak to our excellent and experienced investment consultants. Get in touch today and take charge of your retirement!