There is a tide in the affairs of men, which taken at the flood, leads on to fortune. Omitted, all the voyage of their life is bound in shallows and in miseries. On such a full sea are we now afloat. And we must take the current when it serves or lose our ventures – William Shakespeare in Julius Caesar.
In economics and indeed life in general, the concept of a lifecycle is a powerful one. It captures the idea that the lifetime of each person can be split into three distinct phases: a phase when the individual is dependent on others (usually from birth to the mid-20s), another phase which encompasses their working lifetime (usually from the mid-20s to retirement at age 50-60) and a final post-retirement stage which lasts till death. Now the ‘Lifecyle’ idea, hatched by Franco Modigliani, who would later win the Nobel laureate in economics, was that as individuals were not in control of the first phase, the goal of life is essentially to balance out saving and spending of their income over the latter two phases. Basically, no one wanted to get to old age and revert to the first phase where they are dependent on others for existence. We all dream of retirement in relative comfort.
How do we transfer income to old age?
This is where the concept of pensions comes into play. To a young Nigerian, the word ‘pension’ would probably evoke painful memories about very old Nigerians protesting long delayed payments owed to them by various government agencies. The first pension scheme was enacted in 1889 by the German Chancellor Otto Von Bismarck and it sought to provide a stipend for the elderly aged 70 or more. However, the idea that governments should pay a pension to everyone when they get old is increasingly outdated as governments themselves are deep in debt and are having a hard time balancing the books. As such, the pension fund industry is undergoing an evolution away from era of a defined promise which was dependent on government largesse, towards one where the individual puts away some money during his active lifetime into a piggy bank which he can only access at old age. In Nigeria, this view formed the basis of the Pension Reform Act passed in 2004 (revised in 2014) which makes it mandatory for companies with at least 3 employees in the formal sector to set aside a portion of their monthly earnings for pension contribution. For informal sector workers, there is a provision under the micro pension scheme which provides a vehicle for retirement savings.
The retirement trinity
It is always said, that, if you fail to plan, you are planning to fail. In the retirement arithmetic, there are three variables in the trinity: savings, time and returns.
- How much are you saving?
- hHow long do you save for?
- What is the rate or return earned on your savings?
At every point in time, individuals are in control of only two members of the trinity (time and savings) but NOT returns. The rate of return earned on your savings is a function of capital market trends which is often linked to macroeconomic factors (interest rates, economic growth, exchange rates, commodity prices etc.) and presents the largest risk to retirement savings. Time is a function of WHEN you choose to start saving and HOW LONG you maintain your savings culture/ habit i.e. the discipline of avoiding the temptation to break your savings. And HOW MUCH you save is a function of your income (which is linked to your skill set and knowledge) and your lifestyle (spending habits).
Take advantage of the power of compounding
Albert Einstein once remarked that compound interest is the eighth wonder of the world, he who understands it earns it, he who doesn’t pays it. This is best captured using the rule of 72 which works like this. If an investment scheme promises an 8 percent annual compounded rate of return, it will take approximately (72 / 8) = 9 years to double the invested money. The higher the rate of return the lower the time needed to double the investment. In simple terms, starting to save early and staying the course with a savings culture pays off overtime. A sure route towards enshrining a disciplined savings culture is by having a retirement savings account (RSA). RSAs can be opened at any licensed pension fund manager and they come with a unique identifier which is linked to your National Identity Number with access at retirement. Funds saved under the pension fund system in Nigeria are managed by a custodial arrangement which means that your savings are immune from any adverse events to the pension fund manager. In addition, pension accounts are tax advantaged as contributions from your salary towards pension savings are tax deductible. Pension savings are managed by a professional fund manager who seeks to deliver competitive returns.
“For what it’s worth: it’s never too late or, too early to be whoever you want to be. There’s no time limit, stop whenever you want. You can change or stay the same, there are no rules to this thing. We can make the best or the worst of it. I hope you make the best of it. I hope you live a life you’re proud of. If you find that you’re not, I hope you have the courage to start all over again.” Eric Roth, The Curious Case of Benjamin Button Screenplay
Wale Okunrinboye superintends the investment research unit as Sigma Pensions Limited. He is an investment professional with deep experience across equity, fixed income and macroeconomic research. Prior to joining Sigma Pensions in 2018, Wale worked as a fixed income and currency specialist at Ecobank and before then was as a sell-side research analyst at ARM Investment Managers. He is a CFA Charterholder with bachelors and master’s degrees in economics from Covenant University and University College London respectively.