Preservation fund investments: The hidden risk of going ‘too safe’

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People use preservation funds when changing jobs in order to preserve their savings, which have previously been accumulated in an employer-sponsored pension or provident fund. For this reason, investors may adopt a mindset focused on protecting these savings rather than growing them.

The hidden risk of going too conservative is that your investment may struggle to outperform inflation in the long term, which ultimately means your investment will potentially not experience any significant growth. As much as you want to protect your preservation fund, you also want your savings to grow as much as possible, as this forms part of the money that will provide for your retirement years.

In this article, we will explore in more detail why going too conservative with your fund selection may hamper the long-term growth potential of your preservation fund. We’ll also take a closer look at the role of asset allocation and fees.

What a preservation fund actually does

A preservation fund is a great way of continuing to save for your retirement after leaving a specific job where you have built up savings in a pension or provident fund. Upon leaving the job, the savings in your pension or provident fund can be transferred to a preservation fund without triggering a tax event.

Growth within the preservation fund is also tax-free, therefore allowing for more potential growth due to the greater amount of returns available to be reinvested. Keep in mind that preservation funds don’t allow for any further contributions, highlighting the importance of good returns in order for your investment to outperform inflation and grow over the long term.

At retirement (from age 55 in South Africa), you will convert your preservation fund to either a life or a living annuity. This annuity will then provide you with an income during your retirement. The more that you have saved in your preservation fund over the long term, the more you will have available for your annuity upon retirement.

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The real goal of a preservation fund: Beat inflation over time

The primary objective of your preservation fund should be to consistently return more than the combination of the fees you pay on it plus inflation over time. In South Africa, inflation typically sits at around 3 to 5% a year, which means your investment needs to outperform this and your costs just to maintain its purchasing power.

To achieve this, preservation funds invest across different asset classes such as equities, real estate, bonds and cash. Each asset class plays a different role. Asset allocation plays the biggest role in the performance of your preservation fund, accounting for over 90% of returns, as seminal research from Brinson, Singer, and Beebower shows.

Asset classes such as bonds and cash will add stability to your portfolio, but they are likely to generate lower returns in the long-term. Cash is the most liquid but tends to generate the lowest returns over time. You may, therefore, look to avoid investing too heavily in cash, as this is unlikely to generate returns that will beat inflation.

Real estate can offer good returns, while equities are likely to generate the best returns over the long term, but they are the most volatile of the asset classes. As data suggests, equities have historically produced returns above inflation by around 7% annually over the long term (based on JSE All Share Index performance versus CPI from 1960-2020). Of course, past performance does not guarantee future results.

In short, long-term investing requires balancing the need to beat inflation with the reality of market volatility. A well-constructed preservation fund does exactly that, aiming for growth that protects and increases your savings’ real value over time. H2: The hidden risk of “going too safe” While protecting your savings from market volatility is key, being too conservative can subtly undermine your long-term investment outcomes.

Inflation Erosion

Investing in cash and bonds will provide stability in times of market volatility, but the returns generated are unlikely to be enough to beat inflation in the long term. If we look at a simple example where the returns generated are 4% and inflation is 6%, then your real return is -2% (4 - 6 = -2). Even though your balance appears to be growing in rand terms, its purchasing power is shrinking every year. Over a decade or more, this erosion compounds, leaving you with significantly less real value than you might have expected. This is not to say bonds may not outperform ever – merely that over the course of a lifetime saving for retirement, they are typically a more conservative option.

Opportunity Cost

Avoiding equities might feel safer, but you may end up missing out on long-term growth. Equities have historically delivered the highest returns of all major asset classes, especially when compounded over 20 years or more. By not investing in equities, you reduce the potential size of your future retirement savings, and even a small percentage difference in annual return can translate to hundreds of thousands, or even millions, of rand less over time.

Longevity Risk

Retirees are healthier and living longer today than in the past, which is, of course, a good thing - but it also increases the financial demands at retirement. Many South Africans need savings to last for 30 to 40 years, all while drawing a regular income. If your underlying portfolio is positioned too conservatively, it may struggle to keep pace with inflation and withdrawals, increasing the risk of your capital running out too soon. A balanced approach that includes enough exposure to growth assets can help ensure your retirement savings remain sustainable for the length of your retirement.

How preservation fund fees impact growth

Fees are of major importance when it comes to investments and retirement planning. If you are heavily invested in cash and your real returns are minimal, more of your returns will go towards paying fees. This will once again have an impact on the growth of your preservation fund over the long term. Lower fees, in comparison, may mean that you have more returns available to reinvest and potentially compound and grow over the long term. Let’s look at an example to compare higher fees (3%) with lower fees (1%) to help illustrate the effect that fees may have on your final investment value. We will assume the following factors for this example:

• Investment period of 30 years
• Initial investment of R500K
• Return of 12% per annum
• An inflation rate of 6%

Example 1 (1% Fees): Real investment value is R1.99m

Example 2 (3% Fees): Real investment value is R1.16m

We can see how just a small difference in fees makes a huge difference at retirement. Please note that this example is for illustrative purposes only, and real results may vary. You can learn more about fees here.

As an investor, you should always be aware of the fees being deducted from your preservation fund. You can expect to see some of the following fees:

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

Administration fees: There would be fees charged for the administration of the fund. This would be for tasks related to tax, reporting and similar.

Advisor fees: An advisor may charge both an initial and an ongoing fee for their services and advice.

The Effective Annual Cost (EAC) is a useful metric which was introduced by ASISA in 2015. This allows you to view the total fees and costs that are being charged on your preservation fund over a one year period of time. All factors being equal, a higher EAC would mean that less of your investment returns can be reinvested and potentially grow and compound over time, while a lower EAC means that more of your returns may be reinvested and potentially grow over the long term. Keep in mind that the EAC of an investment is just one factor to consider when comparing service providers.

At 10X, we look to minimise fees so that more of your returns can be reinvested and potentially grow over the long-term. Our fees for most retirement products are 1% or less, depending on your choice of product and the amount that you invest. We keep our fees transparent and simple to understand with no hidden costs. Please explore our product page for the most up-to-date fee information.

How to choose the right asset allocation

As an investor with 10X, you have the freedom to customise your underlying portfolio by choosing from a selection of carefully curated investment funds, each with a different asset allocation and geared towards different investor profiles.

As mentioned, you can expect the best returns over the long term when invested in equities. Further diversifying across the asset classes allows you to take advantage of the different economic cycles while also spreading your risk. You may also consider diversifying your portfolio offshore. This can be a good hedge against any political and local market instability, as well as any depreciation of the Rand. The international market is also bigger than the South African market, therefore allowing access to a wider range of industries.

Regulation 28 of The Pension Funds Act puts a limit on the percentage of your preservation fund that you may invest in both equities and offshore. Current regulations state that you may invest a maximum of 45% of your preservation fund offshore and a maximum of 75% in equities. This is to help investors avoid a poorly diversified portfolio.

When selecting the appropriate asset allocation for you, as an investor, you should consider both your investor profile and your long-term financial goals. When we speak about ‘investor profile,’ we are referring to your risk tolerance levels and investment timelines. Risk tolerance levels are your risk appetite; i.e. how comfortable you are with short-term market volatility. Investment timelines refer to how much time you have for your investment to potentially grow prior to retiring.

If you are an investor with a longer time until retirement age, you may feel more comfortable with a higher percentage of equities in your portfolio. An investor who is quite close to retirement age may prefer more bonds or cash in their portfolio for stability, but you should still ideally consider allocating a portion of your portfolio to equities for growth purposes. Diversification across the asset classes can help balance both risk and reward.

10X offers a range of well-diversified funds, so you can select the right one for your investor profile and long-term financial goals. Our funds are Regulation 28 compliant and include both local and offshore funds. For more information, please visit our fund page.

How a low-fee, diversified index-based strategy helps

Index-tracking is when the asset makeup of a benchmark index is mimicked with the aim of generating the same returns as the index. This kind of strategy focuses on consistent returns, while diversifying across a range of assets, industries and regions, thereby aiming to balance the portfolio and spread the risk. The costs involved are generally also lower, due to the fact that there are fewer activities like research and analysis, and buying and selling costs. This may mean that you have more returns available to reinvest and potentially grow over time.

An active strategy is when a fund manager looks for the best returns. There would be more costs involved here, as this requires more research, analysis and trading costs. These costs may then be passed onto the investor in the form of fees. Actively managed funds often try to time the market, which may mean more volatility.

As data from the SPIVA Scorecards suggests, index tracking may outperform active management most of the time. According to the latest SPIVA South Africa Scorecard (as of 31 December 2024), 60.84% of South African actively managed equity funds underperformed the S&P South Africa DSW Capped Index over the ten years ending 31 December 2024.

At 10X, we use an index-tracking strategy alongside a more active approach to asset allocation management. This allows us to be more cost-effective when it comes to our product offering while still achieving the long-term returns our clients deserve.

Practical checklist: How to avoid going “too safe”

When considering if you are going ‘too safe’ when it comes to your preservation fund, here is a useful checklist to assist:

1. Consider resisting the move to cash after a market dip: Switching to cash after there has been a market dip or crash may result in you ‘locking in’ any losses that have occurred.
2. Review your preservation fund annually: Look at key elements such as fees, performance, your EAC and whether your asset allocation still matches your goals and time horizon.
3. Focus on real returns and not nominal returns: The main goal is for your investment to beat inflation. A positive return that fails to outpace inflation still reduces your purchasing power.
4. Stay diversified and include growth assets: A balanced mix, especially with meaningful equity exposure, helps your money grow over the long term and stay aligned with your investor profile.
5. Choose a transparent, cost-effective provider: Consider a service provider that is transparent and cost-effective when it comes to the fees that they charge. Remember, high fees can undermine long-term growth.

Final thoughts: Preservation funds and playing it too safe

It’s natural to have a strong instinct to want to protect your savings from any volatility but it’s important to consider the consequences of this. Being too protective of your savings may result in stunted growth and your preservation fund struggling to outperform inflation.

Instead, pursuing a well-diversified portfolio which includes equities may help to grow your investment over the long term. Additionally, if you add low fees to this formula, it will allow for more potential compound growth over time. Taking time to strategically structure your preservation fund while focusing on growth may pay off in the long run.

If you need help with setting up your preservation fund, please get in touch with the efficient and knowledgeable investment consultants at 10X. Get in touch today and make the most of your retirement savings.