Investing for retirement - know your replacement level at every stage

Knowing your replacement level at every stage of investing for retirement is crucial for effective retirement planning. As you progress through different stages of life and investing, your financial needs and goals will evolve, and understanding your replacement level at each stage will help you make informed decisions and stay on track for a comfortable retirement.

But first, what is a replacement level?  Also called your funding level, or replacement ratio, it’s simply a projection of the percentage of your last monthly salary that you’ll be able to take as a sustainable, post-retirement income. For example, if you are earning R10,000 a month just before retirement, and your replacement ratio is 75%, you’ll have an income of R7,500 a month once you retire. 

However, recent research suggests that many retirees won’t be able to enjoy such a high replacement ratio and that the average projected replacement level is closer to 40.5% (according to an Alexander Forbes study). If you’re nearing the end of your career, it can be very difficult to make up for this shortfall.  However, if you’re younger there’s still time to take corrective action. Let’s look at different stages of investing for retirement:

1. Early Career Stage: During the early career stage, you may have just started saving for retirement and have a long investment horizon ahead. Knowing your replacement level at this stage helps you establish a baseline of how much you’ll need to save. Calculate how much of your current income you need to replace in retirement, considering your desired standard of living, expected expenses, and inflation. This knowledge will guide you in determining the appropriate savings rate and investment strategy to reach your retirement goals. Because there is a longer time frame until retirement, an investor could consider funds with higher risk assets offering higher potential for return over the long term, such as the M&G Equity, M&G Dividend Maximiser and M&G Property Funds.
2. Mid-Career Stage: In the mid-career stage, you may have already accumulated a significant amount in your retirement savings. Revisiting your replacement level becomes essential to assess whether you are on track to meet your income goals in retirement. Your income and lifestyle expectations may have changed since the early career stage, and it's crucial to reevaluate your retirement needs. Consider factors such as changing family dynamics, housing costs, healthcare expenses, and any major financial obligations. Adjust your replacement level accordingly and reassess your savings contributions and investment allocation to ensure you’re on track. At this stage, growth is still necessary, and an investor may consider the M&G Equity Fund. Another popular choice for retirement investors is a multi-asset fund, such as the M&G Balanced Fund, as they typically comply with Regulation 28 limitations and combine a range of different asset classes into one fund for diversification.
3. Late Career Stage: As retirement draws closer, knowing your replacement level becomes even more critical. At this stage, you need to have a clear understanding of the income you’ll need to maintain your desired lifestyle throughout your retirement. Evaluate how well your savings align with your replacement level and make any necessary adjustments. This might involve increasing your savings rate, making catch-up contributions, or exploring additional income sources to bridge any gaps.
4. Pre-Retirement Stage: As you approach retirement, it's essential to refine your replacement level calculations further. Carefully consider any other sources of capital you might have, such as any discretionary investments (i.e., not in a retirement fund) and property you may own. Could you downsize to a smaller dwelling when you retire, or sell your holiday home, and add the capital you’ve gained to your retirement capital? Determine the percentage of your pre-retirement income that will be covered by these sources and identify any remaining gaps. This knowledge will help you fine-tune your savings plan further and ensure you have a solid financial foundation for retirement.
5. Post-Retirement Stage: Even in retirement, it's important to periodically reassess your replacement level. Monitor your spending patterns, lifestyle changes, and potential healthcare costs. Stay informed about inflation and interest rates and adjust your retirement income accordingly – living annuity products allow you to change your withdrawals every year as necessary. Review your investment strategies, considering conservative options to ensure the sustainability of your retirement savings, while including more aggressive options to generate growth. The M&G Target Income Funds offer an ideal all-in-one solution if you’re looking to draw an income from your investment. Each fund is specifically designed and managed to provide an income of between 2.5% - 7%, with a secondary objective of growing your capital over time.

In summary, knowing your replacement level at each stage of investing allows you to set realistic savings targets, assess your progress, and make informed decisions about your investments. By staying proactive and adjusting your strategies accordingly, you can secure a comfortable and financially sound retirement.

At M&G Investments, we offer a range of local and global funds across the risk spectrum and suitable for the various stages of investing towards retirement, as well as living annuity options and corresponding investment solutions suitable for securing a regular income during your retirement years.