Retirement annuity behavioural biases: How to avoid common mistakes with your RA

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Many investors are aware of the technical details when it comes to their retirement annuity (RA), such as tax deductions and Regulation 28 limiting their equity and offshore exposure. However, not all investors are aware of the behavioural biases that can affect the long-term growth and performance of their retirement annuity.  

Emotional and behavioural biases may cause less-than-rational behaviour, such as panic-selling during a market downturn, chasing high returns, saving inconsistently or ignoring high fees. When it comes to investing in your retirement annuity, your behaviour is just as important as your contributions. In this article, we will explore in more detail the kinds of behavioural biases that investors may encounter, as well as some strategies that can be used to manage these.  

What is a retirement annuity? 

A retirement annuity (RA) is a long-term retirement savings vehicle offering tax benefits to the investor. Contributions that you make to your retirement annuity are tax-deductible to certain limits. These limits are up to 27.5% of your income or R350 000 per annum. Investment returns within the retirement annuity wrapper are exempt from income tax, dividends tax and capital gains tax while invested. This means that there are potentially more returns to compound and grow over the long term.  

Contributions to your retirement annuity may be either in the form of a lump sum contribution or a monthly debit order. These contributions will need to adhere to any minimum limits as per your service provider. You are also able to pause or amend a monthly debit order to meet any changing financial situation that may arise. Upon retirement, currently from age 55 in South Africa, a retirement annuity can be used to purchase a life or living annuity. This annuity will then provide you with an income during retirement.  

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The psychology behind long-term investing  

Retirement saving is a long-term game that can span 30 or 40 years, and this requires plenty of patience. This can be hard in a world where instant gratification is prioritised. Research into behavioural finance by experts, such as Thaler and Kahneman, explains how investors may be prone to certain behavioural biases. This is especially apparent in times of market volatility. When it comes to RAs, we see this amplified even more. 

We should also keep in mind that emotional responses like fear are natural and human. When you recognise these emotions, you can pause, reassess, and stop them from influencing your decisions. The idea is to act based on logic, instead of impulse and emotion. Setting clear goals and tracking your progress can reinforce rational decision-making.  

By making sure to focus on your long-term financial plan, along with aiming for low fees and taking a disciplined and consistent approach to investing, you can help negate any effects of behavioural biases. Below are some of the most common behavioural biases investors face when managing a retirement annuity.  

Bias 1 – Procrastination and present bias 

This is the common tendency to put off saving for as long as possible while spending is prioritised. This is especially true for younger people between the ages of 20 to 40 years, where the thought of retiring is still far off. 

The main negative here is the loss of compound growth. Compound growth over the long term is a powerful wealth-growing ally which can significantly impact the final investment amount that you have available for retirement. Here is an example to illustrate the profound effect of compound growth, together with a conscientious approach to investing: 

Scenario 1: In the first scenario, you start with a R100k lump sum and generate 6% real return over 30 years (‘real return’ is returns minus inflation).  

Scenario 2: In the second scenario, you start with a R100k lump sum, and add R1000 per month to it for 30 years at the same 6% real return.  

In Scenario 1, you end up with approximately R482,000   

In Scenario 2, you end up with approximately R1.5 million 

Note that this example is for illustrative purposes only and actual results may vary.  

How to fix it: You would ideally want to set up a regular debit order to help ensure consistent, disciplined savings. In some cases, you may need to target a higher regular contribution amount in order to play catch-up. This debit order can be increased annually with inflation or as your salary increases.  

Bias 2 – Overconfidence and market timing 

Overconfidence occurs when investors believe they can predict the market more effectively than they actually can. As an investor, you may be too confident in your abilities when it comes to investing. You may try to ‘time’ the market by buying, selling or switching in order to generate better returns.  

Timing the market can, however, be incredibly difficult, even for experienced professionals, as several unpredictable factors influence prices. Overconfidence can therefore lead to poor investment decisions, such as selling during downturns or missing out on rebounds. In the long term, this behaviour can increase transaction costs, reduce returns and lock in losses.  

How to fix it: The best course of action is to always stick to your long-term financial plan and not be distracted by short-term market noise. Choosing a service provider such as 10X, which makes use of an index-tracking investment strategy, means that there is no need to time the market.  

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Bias 3 – Loss aversion and fear of market declines  

As an investor, making a loss is a deep-seated fear. This may result in investors panic-selling during times of market volatility or moving into more conservative asset classes, such as bonds and cash. 

While these actions can provide short-term relief, they can be detrimental to long-term investment performance. Panic-selling may result in losses being locked in and not allowing potential recovery when the market rebounds. Investing in more conservative asset classes, such as bonds and cash, may result in less growth and, ultimately, underperformance of your retirement annuity in the long term.  

How to fix it: Once again, sticking to your long-term financial plan is advised. Don’t be swayed by short-term market volatility. Equities have shown to produce the best returns over the long-term and are also the most likely to outperform inflation in the long-term, so you want to ensure that you diversify your asset allocation and include equities in the mix. While it’s not necessary to check your retirement annuity obsessively, you should review it annually. Making use of 10X’s well-diversified range of funds will ensure that you have broad market exposure, including both local and offshore assets.  

Bias 4 – Inertia and status quo bias  

Inertia is the act of doing nothing when action is required. This bias often arises from psychological barriers such as decision fatigue, fear of making a wrong choice, or simple convenience. When faced with too many options or complex information, investors sometimes feel overwhelmed and default to doing nothing.   

This behaviour could manifest as failing to review or adjust your investment portfolio, neglecting to compare service providers or continuing to pay high management fees despite low-cost alternatives. For example, if you are paying high fees, this may impact the returns you have available to compound over time, which will impact your real investment value at retirement age.   

How to fix it: To counter inertia, you should take the time to review your retirement annuity annually, with a focus on fees, contributions and asset allocation. If necessary, you may find that it warrants making some adjustments. Small, proactive adjustments can enhance the long-term growth of your retirement annuity.   

Bias 5 – Recency bias and performance chasing  

Recency bias is a behavioural bias where a high amount of value is placed on recent events, compared to events that have occurred further back in history. Investors may still have a recent event or performance of a particular fund ‘fresh’ in their mind, and this could make them wary of the same event or performance happening again - or vice versa.   

The result of recency bias is that an investor may make poor investment decisions in an attempt to mitigate the impact of a recent event happening again, or in order to potentially capitalise on a favourable event or fund performance that has happened in recent years.   

How to fix it: You would want to ensure that you again focus on the long term and your long-term financial plan and goals. You would also want to keep in mind that past performance does not guarantee future results and avoid chasing returns. When it comes to asset allocation decisions, this should ideally be selected according to your investor profile, such as your risk tolerance levels and investment timelines.  

Building behavioural resilience: Practical steps  There are a few strategies that you, as an investor, can implement in an effort to build some behavioural resilience. Let’s have a look at some of these strategies in some more detail.  

• Automate your contributions: Here, you would look to set up a regular debit order to help keep you disciplined and consistent when it comes to your savings. 
• Diversify your asset allocation: By diversifying your asset allocation across the various asset classes, as well as locally and offshore, you are reducing your risk levels and likely also your anxiety levels. This may then result in less emotional and knee-jerk decision-making. Asset allocation plays the biggest role in the performance of your retirement annuity, accounting for over 90% of returns, as seminal research from Brinson, Singer, and Beebower shows.   
• Ignore short-term market noise: You don’t want to pay too much attention to short-term market volatility; instead, focus on the long term and your long-term financial goals and plans. 
• Keep it simple: Overcomplicating things can result in more poor decisions being made. For this reason, you should look to simplify things so they are easier to understand and act on.  

These strategies can help you stay on track and avoid emotional decision-making. While this kind of resilience won’t happen overnight, it develops steadily through self-awareness, education and consistent practice. The more that you understand your emotional triggers and behavioural biases, the easier it becomes to not let them control you, and instead make a calm decision based on your financial and retirement goals.  

Retirement annuity fees: Why low fees reduce behavioural stress  

When you know you are paying high fees and that you need to cover these high fees with your investment returns, it may result in you chasing high returns. Higher fees may also mean that you may have fewer returns available at the end of the day to reinvest and potentially grow and compound. Choosing a service provider which offers lower fees may mean that there is less pressure on your RA. There will also be more available returns to reinvest and potentially compound over the long term.  

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The usual fees that you may expect to see deducted from your retirement annuity are the following:  

Administration fees: Administration fees are deducted for tasks related to administration. This would be fees for tasks such as reporting, tax and compliance.  

Management fees: Management fees are those fees that are charged for the management of the fund.  

Advisor fees: Advisor fees are the fees which you would see charged by an advisor for the advice and services that they offer. You may see both an initial and an ongoing fee charged.   

Let’s look at an example which shows the effect of high fees on your real investment value.  

• Investment period of 30 years 
• Initial lump sum investment of R50,000 
• Monthly contributions of R2,000 
• Return of 12% per annum 
• An inflation rate of 6% 

Example 1 (1% Fees): Real investment value is approximately R1.8 million 

Example 2 (3% Fees): Real investment value is approximately R1.3 million 

This example is for illustrative purposes only, and actual results may vary. You can learn more about fees here.  

You should also review your RA’s Effective Annual Cost (EAC). This is a metric which was introduced by ASISA in 2015. This metric allows you to consider and compare the total fees and costs of owning an investment over a one-year period of time. All factors being equal, a higher EAC may mean that there are fewer returns to be reinvested and allowed to potentially grow over time. A lower EAC may mean that there are more returns to be reinvested and allowed to compound over the long term. The EAC would be just one factor to consider when comparing service providers.  

At 10X, we offer a free EAC calculator as a part of our free online suite of tools. This allows you to compare the EAC charged by your current provider with the EAC that is charged by 10X, enabling you to compare and evaluate the various fees. 

10X offers a cost-effective, transparent and easy-to-understand fee structure. Fees on retirement products are less than 1% for most products, depending on the product selected and the amount invested. You can view our most up-to-date fee information here.  

Final thoughts on behavioural biases in a retirement annuity 

Retirement investing includes both a focus on markets and a focus on your own behaviour; these two facets work hand in hand. The first step is to recognise behaviours such as inertia, recency bias or overconfidence in yourself, as an investor, and then take some steps in place to help deal with these behaviours.  

10X’s simplified and transparent approach to investing removes a lot of the emotion from investing and instead puts the focus on getting the long-term results and goals. If you want to find out more about how we do things at 10X, please get in touch with our experienced and knowledgeable investment consultants today!