The role of asset allocation enhancing living annuity returns

A living annuity is a retirement savings investment product where South Africans can invest their hard-earned savings at retirement (currently from age 55 onwards). The living annuity then provides you with an income through your retirement years. Ideally, you need the living annuity to last throughout retirement, so it’s important to find a balance between income drawn, investment returns and the longevity of the living annuity. This needs to be carefully planned and balanced to meet your needs as a retiree, while also pursuing the best returns possible.  

As such, asset allocation is a critical part of potentially getting the best returns, beating inflation and maintaining stability. In this article, we look at the importance of asset allocation in maximising your living annuity returns in more detail. At 10x, we simplify your investments with low fees, a superior track record and an up-front investment approach.  

Understanding living annuities 

A living annuity plays a key role in your retirement plan. The living annuity is funded from capital which has been transferred from an investor’s retirement annuity, preservation fund, or pension/provident fund, upon retirement. It is a way of obtaining an income while retired, as well as keeping the capital funds invested to potentially grow and compound over time. Living annuities provide flexibility in terms of the drawdown rate and asset allocation, as these can be adjusted according to changing needs and financial goals over time. The drawdown rate can be selected annually, and the rate may be between 2.5% and 17.5% per annum. You can also select the frequency of these annuity payments to occur annually, semi-annually, quarterly or monthly.  

As a living annuity is designed to provide for you during your retirement years, it’s important to choose the lowest drawdown rate possible, as this allows more of your returns to be invested and potentially protects you from capital erosion. The flexibility of living annuity income differs from that of a guaranteed annuity, where you are given a set monthly income.  

Guaranteed annuities are insurance-style products that you purchase from an insurance company. They will also provide you with an income, but this income will be a fixed amount for the rest of your life. It cannot be adjusted, although some versions offer inflation-linked increases. Although there is no flexibility, as mentioned, there is also less risk, as the guaranteed annuity will provide you with an income for the rest of your life and is not dependant on the performance of underlying assets. 

What is asset allocation? 

When we speak about ‘asset allocation’, what do we mean? We’re talking about the different mix of investment assets (such as equities, bonds, real estate and cash, both offshore and local) which make up the underlying funds of a vehicle such as a living annuity. The choice of asset allocation is determined by a variety of factors such as income requirements, time horizons and levels of risk-aversion that the investor has. The asset allocation can be adjusted to cater for changing needs and financial goals over time.  

10x offers five different funds under the living annuity ‘wrapper’, which all have different asset allocations to suit different investors, depending on the investor’s goals, market conditions, financial needs and stage of life. There are two flagship funds, three offshore funds and two other multi-asset funds. 

The two flagship funds are the 10x Your Future Fund and the 10x Income Fund. The 10x Your Future Fund, for example, is a high equity fund with a time horizon of at least 5 years. Annualised returns since inception have been 11.4%. The 10x Income Fund is a multi-asset fund that prioritises capital stability, and the ideal time horizon is 3 years or longer. 

It can be daunting selecting the correct funds for your living annuity, so if you need some help understanding the facts, get in touch with the very experienced and knowledgeable investment consultants at 10x. Find out more here.  

Key asset classes within living annuities 

As we have briefly mentioned, the main asset classes that you may see are the following. Within their portfolio, an investor can have exposure to both local and international (offshore) assets. How much of each is legislated by Regulation 28 of the Pension Funds act. Currently, reg 28 funds have a limit of 75% exposure to equities, and 45% exposure to offshore assets.  

• Equities: This asset class generally offers the best potential returns over time, but it is also the most volatile of the asset classes.  
• Real Estate/Property: Less volatile when compared to equities, and also potentially a good hedge against inflation. 
• Bonds: Bonds typically offer lower returns but will provide more stability.  
• Cash: Cash will offer the lowest returns, but it is the most stable and also the most liquid of the asset classes.  

 As an investor, you want to ensure that you have a good balance between asset classes, allowing your income needs to be met, while preserving capital and being positioned for potential long-term growth.

Diversification: The cornerstone of sustainable retirement income 

Diversifying across the various asset classes is a great strategy to take advantage of market growth while mitigating against the typical investment risks. As research over the years has shown, asset allocation is the most important factor in the returns that you, as an investor, receive.   

In other words, the underlying assets that are chosen for investments, and when these asset classes are adjusted, are an important determinant for long-term returns. Another key factor in maximising returns is investment management fees, as high fees compound against you and can potentially diminish returns over time. An investment strategy that makes use of index funds generally has much lower fees than an actively-managed fund, as there are fewer associated costs, like the overheads of research and servicing.  

At 10x, we use index tracking methodologies to keep fees low, combined with a more active approach to asset allocation decisions, in an investment strategy aimed at long-term returns, producing the investment and retirement outcomes that our clients deserve. We aim to hit the sweet spot between the rigidity of typical passive investment strategies and the hyperactive trading of stock pickers. We also do not attempt to predict short-term market movements and respect the long-term relationship between price and value. You can learn more about our investment strategy here.  

How to optimise your asset allocation 

It’s important to be aware of your risk profile, the time horizons you are dealing with, and your income needs when looking at how to optimise your asset allocation. Your asset allocation should also be regularly reviewed to ensure that it correctly reflects your current needs and financial situation. Your drawdown rate can be adjusted annually before your policy anniversary date, so making sure to review your drawdown rate annually before your policy anniversary date would be wise.  

At 10x, you have the freedom and flexibility to customise your underlying investment portfolio by selecting from a range of carefully curated investment funds. With these funds, you can diversify across multiple asset classes such as equities, property, bonds, and even offshore investments. With a higher risk tolerance, you may opt for a greater allocation towards equities. If you’re a more conservative investor, you may prefer a fund with a larger allocation to bonds.  No matter your needs, 10x has a fund to suit you.

The role of asset allocation during market volatility 

In times of market volatility, it is important to keep a cool head and avoid any emotional decisions. A living annuity is considered a long-term investment: We are looking at a life span of between 20 and 40 years, so emotional reactions to short-term events should be avoided, if possible.   

If you need to preserve your capital, you could look at strategies such as reducing your drawdown rate. This allows for more of your capital to be reinvested and for it to potentially grow and compound over time. A drawdown rate of 4% is generally considered to be sustainable, but this is case-specific and dependant on your financial needs, the state of the market, and more. You could also look at adjusting your asset allocation during times of volatility. If you need some more stability in your portfolio, you could look at including more bonds in the underlying assets, which helps to reduce volatility.  

Most importantly, remember that a long-term view should be taken and any knee-jerk reactions to political or world events should be avoided, if at all possible. By staying focused on the long-term results, you are more likely to see your returns potentially grow and compound over time.  

Offshore investment exposure 

Diversifying your portfolio offshore is an effective way of accessing the international market and allowing for any potential positive market returns that may be available. It also helps mitigate against any local market instability and currency depreciation of the Rand. The South African market makes up just a small component of the international market; therefore, including offshore exposure allows for more opportunity. 10x values the importance of diversifying into the offshore market and pursuing the potential growth which may be experienced there. 10x offers three offshore funds in the living annuity wrapper. These are, namely:   

1. 10x MSCI World Index Feeder Fund: This is a 100% offshore fund that is high-equity, with an advised time horizon of at least 5 years. Annualised returns since inception have sat at 15.8%. To learn more about this fund, click .  
2. 10x International High Equity Fund: This equity fund has 70% offshore exposure, also for a timeline of 5 years or more. Annualised returns have been 11.8% since inception. More information on this fund can be found .  
3. 10x International Medium Equity Fund: This is a medium equity fund which has more than 60% of its assets invested offshore. A timeline of more than 5 years is advised. Annualised returns have been 11.6% since inception. To find out more, click . 

The impact of fees on living annuity returns 

Fees can have a profound impact on your living annuity’s returns. High fees can potentially deplete your returns and affect your capital; this is especially the case when these high fees are compounded over time. A fee of say, 3%, may seem small, but when this is compounded over 20 or 30 years, it can have a substantially negative impact on your capital.   Let’s look at a practical example where we compare the fees of 3% versus the fees of 1%, assuming that everything else is kept equal.  

• Investment of R100,000 
• Return of 12% per annum 
• Inflation of 6% 
• Time period of 30 years  

 Scenario One (1% fees): After 30 years, the real investment value is R398,578.  

Scenario Two (3% fees): After 30 years, the real investment value is R231,004.  

In this example, the higher fees erode your net investment returns over time. As you can see, a difference of just 2% in fees was equal to R167,574 - or 42% - less. The effect of higher fees is evident in the lower potential returns that may be realised over the longer term. Note that the above example is for illustrative purposes only and actual results may vary. You can learn more about how fees affect returns here. 

There are various types of fees which you may see charged on your living annuity, such as:  

Administration fees: These are the fees charged for the administration involved with the fund, reporting, tax and similar.  

Advisor fees: Fees which an advisor may charge for their advice are termed advisor fees. You may see an initial and ongoing fee.  

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

10x charges a single management fee structure for retirement products, and the fee decreases as your investment grows. There are no upfront, advice, or exit fees, and you do not have to worry about potential penalties for adjusting your investment strategy.  

The Golden Equation for Retirement 

The Golden Equation is a framework that helps with financial planning. The whole principle behind the golden equation is easy to understand: For long-term sustainability, your total expenses (including withdrawals from savings, fees, and inflation) should aim to equate to or remain below the returns your investments generate. Essentially, Investment Returns ≥ Inflation Rate + Fees + Drawdown Rate. 

In order to help make your savings last throughout your retirement years, balancing the factors mentioned above is key. The golden equation is a great guideline to work from when trying to achieve long-term sustainability. Note, however, that investment returns fluctuate and there are no guarantees.  

Living annuity asset allocation summary

As you have seen, asset allocation plays a major role in helping you meet your income goals as a retiree. As an investor, you should understand your needs, requirements and market conditions; using this information wisely to make informed, rational decisions regarding your living annuity to ensure you are able to meet your needs and goals over the long term. 

At 10x, we strike the perfect balance between rigid passive investing and hyperactive trading. We believe in simplifying investments with low fees, a straightforward approach, and a proven track record. To learn more about 10x or the role of asset allocation in living annuities, feel free to speak to one of our experienced investment consultants.