The hidden cost of overly cautious investing in living annuities

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Decisions surrounding the way your funds are invested during your retirement years are extremely important, as they can effect the level of income you draw and indeed the amount of capital in your living annuity. Understandably, a common fear that many retiree have relates to market volatility: what if my investments lose value? This fear can result in retirees structuring their asset allocation conservatively, in a way that involves investing heavily in bonds and cash.  

It is a natural inclination to be conservative when investing, especially as you age. However, this may result in more harm than good in the long run, as investments may struggle to generate the returns needed to cover factors such as fees and inflation. In this article, we delve into the details and risks surrounding overly cautious investing, and in particular, look at how it may impact your living annuity. We’ll also discuss how 10X’s investment strategy can benefit retirees.   

What is a living annuity? 

A living annuity is a post-retirement investment vehicle that provides retirees with an income, while still keeping the capital funds invested to allow for potential growth. As an investor, you can select your drawdown rate annually. The drawdown rate is the percentage of the total value of the living annuity that is drawn as an income each year. You may select a drawdown rate of between 2.5% and 17.5% per annum, prior to the policy’s anniversary date. 

The idea is to select a sustainable drawdown rate that ensures your capital isn’t depleted too quickly. A drawdown rate of 4% is generally considered to be sustainable by financial experts, but nothing can be guaranteed. If you select a drawdown rate that is more than 4%, you run a higher risk of using up your savings. Remember, your savings need to last you throughout your retirement years, and ideally be passed on to nominated beneficiaries. 

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You can select the frequency at which you would like to receive your payments as well. This may be annually, biannually, quarterly or monthly. The onus is on you, as the investor, to manage your living annuity, and in particular, your drawdown rate, to ensure its sustainable and able to last you for the rest of your life once you’ve retired.  

Understanding asset allocation 

A living annuity also offers flexibility in terms of asset allocation. In other words, the underlying funds where you decide to invest your capital. As an investor, you have the freedom to customise your underlying portfolio by choosing from a selection of carefully curated funds, each with a different asset allocation and geared towards different investment profiles. There is a mix of different asset classes to choose from, usually including equities, bonds, real estate and cash, as well as offshore investments.  

Bonds and cash are the more stable asset classes, which is why retirees who are worried about market volatility and risk may prefer to direct investments here. They are, however, also likely to realise lower returns than those you may expect to see generated by equities. Equities are the most volatile of the asset classes, which is why overly conservative investors may avoid them, but this can be a grave mistake.   

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Data indicates that 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). Keep in mind, however, that past performance does not guarantee future results. 

Risk-tolerant investors may feel more comfortable with investing heavily in equities compared to more risk-averse investors, who are more likely to lean towards investing in more stable assets, such as bonds and cash. The key is to find the right balance. 

Diversifying across the asset classes may allow you to take advantage of the different economic cycles. You may also wish to consider diversifying offshore to benefit from any potential market gains in the international market, as this can also add some protection from local market instability, which could result in depreciation of the Rand.  

Why some retirees gravitate toward cautious investing 

There are plenty of reasons why retirees may gravitate towards cautious investing. Firstly, retirees may have low risk-tolerance levels. This means that they are not comfortable with market volatility and the potential for losses in investment value, and therefore wish to avoid taking on any risk. For this reason, retirees may prefer to invest more heavily in cash and bonds in an effort to minimise volatility and the risk of a loss in capital.   

Secondly, having experienced a recent market crash may also mean retirees are even more cautious with their investing habits. For example, an event such as COVID-19, which resulted in a market crash, may still be at the forefront of a retiree’s mind. This may then result in overly cautious investing.  

Thirdly, retirees often live on a fixed income with limited opportunities to replace capital. As such, protecting what they have already saved becomes a higher priority than chasing higher returns.   

Finally, many retirees also face increased financial responsibilities related to healthcare costs, long-term care, and upholding the same standard of living. Financial obligations can often reinforce a desire for safer, more predictable investments that provide stability and steady income.    

The hidden risks of overly conservative portfolios  

As mentioned, retirees may be risk-averse and lean towards bonds and cash, viewing them as safer options to reduce exposure to market volatility. But failing to recognise the risks, such as longevity risk and inflation, can be a huge mistake. Being overly cautious in your investments can potentially lead to the following:   

• Lower real returns: While bonds and cash provide stability, they generally offer lower returns compared to equities. Over time, this can limit the growth of your savings and reduce purchasing power.  
• Capital depleting too quickly: When you rely heavily on low-yielding assets, you may be forced to draw down savings faster than anticipated to meet financial needs like living expenses. This can increase the risk of running out of money during your retirement years.  
• Living annuity is unable to beat inflation: An overly cautious living annuity may not generate the returns needed to outpace inflation. This can reduce the real value of income, which makes it more difficult to maintain the same standard of living over time. 

As you seek to find balance within your living annuity, consider The Golden Equation. This is a framework that can be useful when considering the long-term sustainability of your living annuity. It is summed up as follows: Drawdowns + Fees + Inflation ≤ Return on Investment. For example, if your drawdown is 5%, fees are 1% and inflation is 6%, you need a return of at least 12% to maintain your purchasing power.   

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This means that you would ideally want your living annuity returns to be equal to or greater than the sum of your drawdown rate, fees and the inflation rate. Balancing these factors can play an important role in the sustainability of your living annuity throughout your retirement years. Of course, investment returns do fluctuate and can’t be guaranteed.   

Inflation is inevitable and always needs to be factored in when considering your living annuity. It has the effect of reducing the purchasing power of your money. This means that the bag of goods and services that you are able to purchase with a certain sum of money reduces each year. Inflation in South Africa is typically around 5% to 6%, and this should always be kept in mind when investing.  

While it may seem safer to lean heavily on bonds and cash, doing so without considering the broader risks can hurt the long-term sustainability of your retirement income. The goal should not be to avoid risk altogether, but rather to learn to manage it wisely. A well-diversified portfolio that balances stability with growth potential can give you both peace of mind and protection against the risks of inflation and longevity. 

Finding the right balance: A smarter asset allocation 

By targeting a more diversified portfolio, you can spread your funds across the different asset classes, instead of having all of your eggs in one basket. As mentioned earlier, this allows you to take advantage of any potential good returns that occur in certain asset classes while also protecting against any losses that may occur in other asset classes.   

A living annuity is considered a long-term investment which may span from 20 to 40 years. You may wish to adjust your asset allocation as you move through your retirement years. Initially, you may prefer a more aggressive asset allocation which has a higher percentage of equities - for example, 50% equities, 30% bonds, 15% real estate and 5% cash. As you move into later retirement, you may wish to adjust your portfolio and choose an asset allocation geared to a more conservative investor profile – for example, 30% equities, 40% bonds, 10% in real estate and 20% cash.   

10X offers a wide range of carefully selected funds diversified across the various asset classes with the aim of pursuing excellent returns. Each fund is geared towards a different investor profile who may have a different risk profile and living annuity time horizon. 10X also offers the option to invest your living annuity 100% offshore. Let’s have a look at some of the funds offered by 10X in the living annuity wrapper:  

10X Moderate Fund: The 10X Moderate Fund is suited to investors seeking capital growth with a lower level of volatility than a high equity portfolio over the medium to long-term. The portfolio has a greater allocation to growth assets than to defensive assets, but has a lower risk than that of a pure equity fund. The recommended time horizon is 3 years and longer. Fund exposure is set at 66.2% local and 33.8% offshore. 

10X Defensive Fund: The 10X Defensive Fund is best for investors who want a steady level of income together with capital growth at low volatility over the medium term, achieved with cost-effective exposure to different local and international classes. The portfolio has a higher allocation to defensive assets than to growth assets and has a recommended time horizon of 1-3 years and longer. The risk profile is lower than a medium equity fund. Fund exposure is set at 73.5% local and 26.5% offshore. 

10X Income Fund: The 10X Income Fund is designed to provide investors with a high level of income and long-term capital stability through cost-effective exposure to a comprehensive range of local and international interest-bearing assets. The fund is best suited to those with a time horizon of 3 years or longer looking to preserve wealth, as returns may fluctuate over shorter periods. Fund exposure is set at 84.4% local and 15.6% offshore. 

The Importance of Fees 

Fees are often overlooked by retirees, but they can have a profound impact on the potential growth of your living annuity. The typical fees that you can expect to be charged on your living annuity are as follows: 

Advisor fees: The fees charged by an advisor for their services. This may be both an initial and an annual fee. 

Management fees: The fees charged for the management of the fund. 

Administration fees: The fees charged for tasks related to administration, such as reporting and compliance tasks. 

As an investor, you should be aware of the Effective Annual Cost (EAC) of your investment. This is a standardised measure introduced by ASISA in 2015. It allows you to see the total costs and fees associated with owning an investment over a one-year period of time. All things being equal, a higher EAC may mean that there are fewer returns to be reinvested and potentially grow over time. A lower EAC might mean that you have more returns to invest, which may potentially compound over the long term. When evaluating service providers, the EAC would be just one factor to consider.  

This EAC calculator, offered by 10X, is a free tool allowing you to compare the EAC of your current service provider with the EAC charged by 10X. You can then make an informed decision about whether it makes sense to switch to a service provider with lower fees or not.  

Based on a 40-year investment horizon, research shows that just a 0.5% increase in fees can reduce your final retirement amount by up to 20%, assuming all other factors remain consistent. This is based on the compounding impact of fees over time. This example is for illustrative purposes only, and results may vary. You can learn more about fees here.   

10X offers a simple and transparent fee structure, which makes it easy for all investors to understand. Fees are usually around 1% or less for most of our retirement products, depending on the product chosen and the amount invested. Please visit our website for the most up-to-date fee information. 

How 10X’s strategy aligns with sustainable growth  

When choosing a service provider and a living annuity, you’ll need to consider the type of investment strategy that you prefer. Some providers will use an active investment strategy, and others will opt for index tracking.  

Index tracking occurs when the asset allocation a benchmark index is mirrored in an attempt to match the performance of that index. As there is less research, analysis, and buying and selling involved with this strategy, it can be a more cost-effective choice.  

On the other hand, an active investment strategy involves the expertise of a fund manager. The fund manager aims to choose the winning stocks which will produce the best returns. This involves a lot of research and trading, which can make it a less cost-effective strategy, with the higher costs passed onto the investor.  

As data from the SPIVA Scorecards suggests, index tracking may outperform active management most of the time, especially over the longer term. According to the latest SPIVA South Africa Scorecard (as of 31 December 2024), 60.84% of South African actively managed equity funds underperformed the S&P South Africa DSW Capped Index over the ten-year period ending 31 December 2024.  

At 10X, we use an index tracking investment strategy while also taking a more active approach to asset allocation. We focus on inflation-beating results and getting the outcomes our clients desire as they move towards retirement. To read more about our investment strategy, clickhere.  

Final thoughts on overly cautious investing in living annuities 

In essence, overly cautious investing may not produce the required results over the long term, despite feeling like the safe choice. The key to a sustainable retirement is to find the right balance. 

When managing your living annuity, you need to factor in fees, inflation and your drawdown rate. Regularly reviewing your living annuity with a focus on asset allocation, drawdown rates and keeping fees low will help to keep your living annuity on track and potentially more sustainable. Ideally, you want to focus on growth whilst also managing risk.   

If you have any queries regarding your living annuity or wish to find out more about the 10X living annuity, get in touch today and take charge of your retirement!