Default regulations: you still need to make active choices
Shreekanth Sing, Technical Legal Adviser, PSG Wealth
Having default retirement strategies in place does not take the responsibility away from you to consider appropriate investments or holistic financial planning needs. As of the end of August this year, when the Minister of Finance released the final retirement fund default regulations, these prescribe a set of default strategies, which retirement funds must implement in the long-term interests of members. These are broad strategies and they cannot cater to everyone’s unique circumstances, so it’s important to understand them without assuming they are right for you.
More detail on default strategies
Retirement funds must apply three mandatory default strategies: default investment portfolio, default annuity and default preservation strategies.
The default investments need to be managed within the confines of Regulation 28 of the Pension Funds Act, which aims to protect investors by encouraging sound asset allocation decisions. By limiting the exposure to certain types of assets, the regulator aims to ensure that investors don’t ‘bet’ all their money on potentially volatile asset classes, putting the ability to retire comfortably at risk.
Default options aren’t one-size-fits-all solutions. Pension providers usually offer a range of funds, so you can choose from several broad investment strategies that are suitable for most people. If you don’t make an active choice yourself, the pension provider will invest your pension in a ‘default’ fund that’s designed to suit as broad a range of people as possible. While this option will be selected with care, this may not be the optimal solution for you. For example, some investors have a longer investment horizon and higher risk appetite and may want to choose a more aggressive fund.
You should therefore not just assume the default will meet your needs, you need to understand your objectives and risk profile clearly.
Understand your objectives and risk profile
Risk is the probability of losses relative to the expected return on any particular investment. Putting it simply, it measures the level of uncertainty of achieving the returns you expect. It is important to remember that riskier investments like shares play a crucial role in generating long-term returns.
Take the right risk
It is important to know what level of investment risk you are comfortable taking – and can afford, coupled with understanding the fund you are selecting. A company’s website and their minimum disclosure documents (fund fact sheets) should provide an understanding of what the fund is aiming to achieve, who the key investment personnel are, and what the investment process is.
Different philosophies will resonate with different people. There’s no right or wrong philosophy, but it is important to know how the manager you choose will manage risk and protect capital when markets are falling. It is also important to be sure the manager will apply this philosophy consistently over time.
Most retirement funds regularly screen the options they offer members, but you will still need to do some basic homework before you make a choice. Once you have made the choice, it is important to strike a balance between staying disciplined and reviewing your decision from time to time to make sure your retirement savings are on track.
The full picture
Costs may sound insignificant when expressed as a percentage, but can add up to a substantial amount when compounded over time. Fees can have a considerable effect on your eventual investment return, so make sure you are paying a fee that’s reasonable. Considerations include:
Is the cost in line with other funds in the same category? The fund fact sheet will show the total expense ratio (TER) of the fund, which can be compared to those of other funds to get an idea of whether costs are reasonable.
Does the fund charge a performance fee and, if so, how is this calculated? For example, an equity fund that charges a performance fee when the fund’s benchmark is CPI should ring alarm bells and begs the question: Is the fee reasonable, given the expected return?
There is an ongoing debate about passive versus active management. While it is true that passive funds are usually cheaper, they also replicate a specific index. In South Africa, with its unique market structure, this can have real implications for your portfolio construction. It also means you are allocating more to sectors that are performing well, and that you could overlook future winners that could offer good growth opportunities.
Making choices about retirement can be overwhelming, especially in light of market uncertainty. However, making the right choice is more important than ever. Since your retirement savings will play a big role in determining how you spend your golden years -and the more time you have to save, the better - it is well worth consulting a qualified financial adviser.
Source: Claire Densham Communications