MONEY CLINIC | I'm a pensioner with R2.5m to invest. What should I do with it?

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Investing your entire retirement savings into cash is also not advised, says Lauren Davids.
Investing your entire retirement savings into cash is also not advised, says Lauren Davids.
Nitat Termmee

A pensioner with R2.5 million wants to know the best way to invest his money over the next ten years.

He writes:

I would like to know what is the best option for a pensioner with R2.5 million available: buy property and rent it out, or put into bank for interest? Term is ten years.

Lauren Davids, senior investment consultant at 10X Investments, responds:

We are unable to give you a definitive answer to your question without doing a full financial-needs analysis. We can only provide you with information and draw your attention to the relevant underlying investment principles.

Assuming the R2.5 million represents your only retirement asset, we would not recommend either option. The main problem is lack of diversification. In a typical retirement investment portfolio, you would look to diversify across different asset classes and markets and securities.

This protects you against some or other market development ruining your nest egg.

For example, when interest rates fall, interest income is lower, but it is usually positive for the share market. Alternatively, when the share market falls, bond prices tend to rise, and cash holds its value. The ideal is to hold a diversified portfolio of assets with a market risk profile (exposure to the share market) that is appropriate for your time horizon and your tolerance for volatility.

You will not have that diversification if you own one, or even a few, "buy-to-let" properties. You won't be protected against a broad downturn in the rental market, or the economy. And one rotten tenant can play havoc with your finances. With property, you also cannot diversify across time. Unlike a financial investment, you cannot enter or exit the property market gradually (as one does when adding to or drawing from an investment fund). This increases timing risk: you may unwittingly be buying your single asset when prices are high and/or forced to sell when prices are low. 

"Buy-to-let" properties also come with considerable operating risks: your property may stand empty for a few months, your tenant may fall into arrears, you can incur unexpected maintenance or eviction costs, interest rates can rise, special levies happen, rentals can come under pressure, or property rates go up unreasonably. Unlike a financial portfolio, you cannot de-risk your property portfolio in retirement to secure your income. Even without a bond, you are at the mercy of your tenants for your monthly income. You would need to own a good few such properties to mitigate against this.

Two other features that commend a retirement plan are low costs and simplicity.

With property, the holding and transactions costs are high. Plus, there is the hidden cost of an inefficient market: it is illiquid, transactions take months to settle, bid-offer spreads are wide, and inevitable legal processes to assert your rights are slow and expensive, and often ineffective.  

Last, but not least, you want to keep your retirement finances low touch. Managing "buy-to-let" properties is anything but, and often requires a considerable investment of your time, nerves and energy.  

Cash is high-risk

Investing your entire retirement savings into cash is also not advised. It is a very simple, but not a "safe" option for investors with a long-term perspective. This also includes many retirees who may still have an investment time horizon of ten, 20, 30 years. For them, holding just cash is a high-risk proposition.

Cash is considered a low-risk investment because it provides an almost certain return over the contract period. The downside is that rewards are typically not great. Savers are usually compensated only for inflation and a little bit extra, say 150 to 250 basis points (unlike with shares where the long-term return has been between 6% to 7% p.a. after inflation). If the "little bit extra" goes much higher, it usually means savers are taking on more risk, either by locking up their money for longer, or trusting their savings to a provider with a lower credit rating.     

Because cash offers such a low real return, relying exclusively on interest from cash savings increases the risk that you begin eating into your capital and suffer a drop in lifestyle in future and possibly outlive your savings. Earning a higher return over the long-term mitigates against this.

The other problem is that interest rates fluctuate so, if you plan to live off the interest income, your income may fluctuate from year to year. You can, of course, lock in your interest with a term investment (as you propose) but then you run the risk that inflation increases and that your real (after-inflation) interest return becomes negative.   

Even if that does not happen, living off interest income creates a false illusion that the underlying capital is being preserved. In truth, the purchasing power of that money is being steadily eroded by inflation. The interest you receive will afford you less every year and you would eventually have to access the capital to preserve your lifestyle.

Different asset classes

Rather than choose between cash and property, a more prudent approach would be to spread your savings across different asset classes. Although it may make your portfolio’s value more volatile over shorter periods, it should better protect you from inflation and concentration risk, and make your savings last longer and afford you a higher income.

Such diversification is easily achieved by investing in a low-cost, balanced multi-asset fund, either within a living annuity, or directly via a unit trust fund. Both these structures facilitate automatic monthly income payouts. This should provide you with more peace of mind, knowing all your eggs are not in one basket and that your portfolio is being regularly re-balanced, all of which adds to the prospect of a more secure retirement. 

However, if your mind is made up, and your choice is between property or cash, the answer would depend very much on the specific circumstances, and whether the property’s rental yield after tax will beat the after-tax interest rate on a ten-year term deposit. There are so many unknown variables, especially as regards the property you have in mind (monthly rental and running costs) that this would have to be evaluated on a specific case-by-case basis, while allowing for a considerable margin for safety, in case these variables change in future.

All things considered, keeping your money in a term deposit (ideally shorter than ten years) would provide you with more simplicity, more certainty, more flexibility and more options should you change your mind in future. This holds even if you could secure a higher yield initially on a property deal: we don't believe that the yield will be so much higher that it offsets the enormous concentration risk you assume with putting all that money into a property investment.        

  • Questions may be edited for brevity and clarity.

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