Investing for retirement

Article #695 by Edward Rizzo - Published Weekly

Many people undoubtedly worry whether their savings being set aside throughout their working life are likely to generate enough income to maintain a good standard of living once they reach retirement age.

Unfortunately, in an era of very low interest rates which may not change radically in the near-term, even largish amounts of savings produce modest amount of income due to the current interest rate environment.

As such, the many Maltese individuals who maintain too large an amount of funds sitting idle in bank accounts offering close to zero interest rates and hoping to live-off their accumulated savings, must sooner or later seek to invest elsewhere to generate income in order to supplement their future pension income. This is the reason why pension funds invest the large majority of their assets across equity and bond markets as opposed to maintaining high levels of cash.

The financial statements recently published by all the retail banks in Malta give ample evidence of the excess savings set aside by numerous Maltese residents which are not being managed effectively to generate an income stream by these savers.

Although maintaining a high level of cash across various banks by Maltese residents via fixed-term deposits was one of the main strategies from an investment-planning perspective until a few years ago when interest rates were at higher levels, the situation is totally different in current circumstances. As such, there is a clear case for such individuals holding excess levels of cash lying idle to build a balanced portfolio composed of a selection of shares, bonds and funds.

Individuals who have invested across the local and international financial markets throughout the years can attest to the positive performances achieved despite the random stock market shocks which are inevitable from time to time. In fact, despite the occasional bear markets, the MSE Equity Price Index generated a compound annual growth rate (CAGR) of 5.7% since 1996 while the MSE Equity Total Return Index, which includes dividends, produced a CAGR of 8.7%. When analysing data for international equity markets over a very long-term horizon, it transpires that the Dow Jones Industrial Average and the S&P 500 generated returns of about 10% annually.

The affinity to the property market by the Maltese is very well-known and it is common practice for several individuals to also direct excess savings into a number of investment properties in order to generate a rental income stream. While this is also a good strategy to generate an income stream to supplement one’s pension, there are also risks in being overly exposed to a particular asset class. Moreover, there are other factors that one may need to consider when deciding on the overall allocation between investing directly in property as opposed to building a balanced investment portfolio of securities listed on local and international stock exchanges. When deliberating this, investors must consider the time it takes and the costs involved to administer a portfolio of properties, the visibility of an income stream given the duration of a residential rental contract which can be generally less than five years as opposed to a fixed term nature of a bond (say 6 years or 10 years) together with several other considerations including liquidity risk.

In essence, it is always advisable for investors to own a diversified portfolio of assets to generate an additional income stream and not maintain excess funds lying idle at a time of very low levels of interest on bank deposits.

Although the Maltese capital market may be rather illiquid and is overly reliant on a number of companies operating within the hospitality and property sectors, there are nonetheless a number of opportunities which would enable investors to build a portfolio and generate relatively attractive returns compared to the near zero rates of interest on bank deposits. As indicated in last week’s article, a number of companies whose equity is listed on the MSE also offer good dividends and a high ROE which should translate into a higher share price over time. Moreover, there are a number of bond issuers who despite the pandemic still have a strong balance sheet enabling them to easily honour their debt obligations going forward.

Across the more developed international equity markets, there are numerous ways one can obtain exposure and the most common approach nowadays is via the use of Exchange Traded Funds. These instruments allow investors to gain exposure to either specific markets such as the S&P 500, the FTSE 100, the European markets, etc, or to specific sectors such as technology, financials, consumer staples, retail, etc.

The use of such ETF’s is widely advocated by the legendary investor Warren Buffett. In the recent annual meeting for shareholders of Berkshire Hathaway, Mr Buffett displayed the top 20 stocks in the world by market value as at 31 March 2021 compared to that as at 31 March 1989. It transpires that none of the largest companies 30 years ago feature on the same list today which includes Apple, Saudi Aramco, Microsoft, and Amazon. Buffett’s main lesson for new investors was that the change in the individual top stocks over time showed the difficulty in selecting individual companies and the importance of having a broad, well-diversified portfolio which can be easily obtained through ETF’s.

Mr Buffett also spoke about the ease of entry into the capital market compared to the length of time and liquidity issues when buying commercial building or residential apartments. The Chairman and CEO of Berkshire Hathaway advocated that the stockmarket allows investors to own parts of different businesses with relative ease. He argued that the stockmarket offers the opportunity to participate in assets that generate consistent earnings with a relatively low cost of entry and also very quick to execute. Mr Buffett said that investors generally may not understand that the market enables them to own parts of the largest companies in the world clearly making reference to some of the very successful US tech companies.

While the past is not indicative of future results when it comes to the investment world, obtaining a mix of sustainable income and long-term capital growth that some shares can deliver should prove to be a good plan for retirement purposes. As most people think about maximising their income during their employment, due consideration must also be given on how the excess savings generated during employment could sustain a person’s standard of living once retired. The stock market is clearly an important tool that should be looked at more favourably to achieve this important objective.

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This article was produced by Edward Rizzo, Director at Rizzo Farrugia, which is a company licensed to undertake investment services in Malta by the MFSA under the Investment Services Act, Cap. 370 of the Laws of Malta and a member of the Malta Stock Exchange. The company’s registered address is at Airways House, Fourth Floor, High Street, Sliema SLM 1551, Malta.