The impact of inflation on your preservation fund (and what to do about it)

A preservation fund can be a useful retirement savings vehicle, especially for those transitioning between jobs or expecting a career change before retirement. Preservation funds are designed to safeguard retirement savings during job changes or shifts in employment status, ensuring your accumulated savings remain intact and continue to grow until your retirement rolls around. By preserving your pension or provident fund savings in a preservation fund, the capital continues to benefit from compound interest and tax incentives, setting you up for a financially stable retirement. 

While keeping your retirement savings intact via a preservation fund is a smart move, you’ll still need to consider the ramifications of inflation on your savings. As prices continue to rise, the value of money diminishes, so the goods and services you can buy with a specific amount today may be considerably less than what that same amount could purchase in the future.  

In this quick read, we will be exploring the impact of inflation on preservation funds as well as what to do about it. We will also be touching on the 10X Preservation Fund and why our product is an outstanding option for investors looking to mitigate inflation risk. The effects of inflation can be greatly detrimental to long-term savings of any kind, and a preservation fund investment is no exception. This is why our 10X underlying funds are intentionally designed to generate consistent returns that can outpace inflation, and our low fee structure ensures that more of your money stays invested so that your retirement savings can see consistent growth.  

With a keen understanding of how inflation affects your preservation fund and how to minimise inflation risk, you can make informed decisions to protect and potentially enhance the value of your retirement savings, securing sufficient funds for when you reach retirement.  

What is a preservation fund?  

A preservation fund is a retirement savings investment product that allows you to transfer your pension or provident fund savings when leaving a job, without incurring tax penalties. Rather than withdrawing your funds and halting your retirement savings growth, you can move your money into a preservation fund with a tax-free transfer and maintain the momentum of your retirement savings. Preservation funds offer tax efficiency as growth is not taxed, flexibility during and after job transitions, and the convenience of investing pension or provident savings from different employers over time. 

Note: You cannot continue to add new contributions from different funds or employers to the same preservation fund. Each new pension or provident fund requires the establishment of a new preservation fund. 

By choosing to preserve your savings instead of cashing out, your funds can continue to grow with maximum compound interest until you need it for retirement.  

The impact of inflation on your preservation fund 

Inflation refers to the general rise in prices over time, which can in turn decrease the purchasing power of your savings. For preservation fund investors, the danger lies in the combination of inflation and fees outpacing the returns generated by your investments within the fund. Over the years, the real value of the money you’ve saved can be significantly reduced, and you could run the risk of falling short of your retirement goals. To combat this risk and ensure financial security in retirement, your investment returns need to comfortably exceed the rate of inflation. 

For example, let’s say you have saved R100,000 in your preservation fund. If the annual inflation rate is 5%, this means the cost of goods and services will increase by 5% each year. In one year, the purchasing power of your R100,000 will be equivalent to only R95,238 in today's money. 

Let's assume your preservation fund investments return 5% annually, the same as the inflation rate. After a year, your fund grows to R105,000. Adjusted for inflation, the real value of your fund remains R100,000 in today's money. Essentially, you have neither gained nor lost purchasing power. 

However, if your fund’s return is only 3% in the same scenario, your fund grows to R103,000. Adjusted for inflation, the real value of your fund becomes approximately R98,095 in today's terms. This means you've lost purchasing power, as the actual value of your fund has decreased relative to the cost of living. 

Let's extend the example by including the effect of fees on your preservation fund investment. We will assume the same initial amount of R100,000 is invested, the annual inflation rate remains at 5%, and the fund's gross return is also 5%, but now we consider an annual investment fee of 1%. With an annual investment fee of 1%, your net return becomes 4% (5% gross return minus 1% fee). After one year, your fund grows to R104,000. Adjusted for inflation, the real value of your fund is now approximately R99,048 in today's terms.  

As you can see, the fees you’re charged on your investment will further reduce your real returns, resulting in an even greater loss of purchasing power. Over time, the combined impact of inflation and high fees can compound and your financial security in retirement can be jeopardised. Even if your investment returns match inflation, fees can still severely impact your savings which is why it’s important to keep a stern eye on the fees you’re paying on your investment.

The role of fees in retirement savings growth 

While inflation is out of your control, you do have a say in the fees you pay on your investment. As mentioned above, fees have the potential to chip away at your savings and when coupled with inflation, you could run the risk of running out of money in retirement.  

Did you know that a 1% difference in fees can mean as much as 30% less in retirement? 

This is why you’ll want to pick a preservation fund provider that offers low fees. Low fees mean more of your money is being reinvested and benefitting from compound growth that can help you keep pace with inflation. On the other hand, high fees can stack up over time, working like compound interest in reverse, and reducing the total value of your investment.  

For example, say you invest R100,000 in a preservation fund that is expected to earn an annual return of 6% before fees, with an inflation rate of 6%. We'll compare two scenarios over a 20-year period: one with a low annual fee of 0.5% and another with a high annual fee of 2%. 

In the low fee scenario, the fee is 0.5% per year. The net annual return on your investment is 5.5% (6% return - 0.5% fee). Over 20 years, the nominal future value of your investment would grow to approximately R291,898. However, after adjusting for a 6% annual inflation rate, the real value of your investment in today’s terms is reduced to approximately R100,000. 

In the high fee scenario, the annual fee is 2%. The net annual return is 4% (6% return - 2% fee). Over the same 20-year period, the nominal future value of your investment would only grow to R219,112. After accounting for the 6% annual inflation rate, the real value of your investment in today’s terms is approximately R75,000. 

Breaking down preservation fund fees 

When investigating the various and total fees you’re paying for your preservation fund investment, it’s important to distinguish fund performance from net investment returns, alongside understanding how fees and inflation combined can impact your retirement savings. So, let’s break it down: 

Total expense ratio (TER) 

This is the cost of investing, for example what your investment manager pays to invest money (buy and sell investments) in a fund. These costs form part of your investment fee, but not all of the costs your investment incurs are included. 

Total investment charge (TIC) 

This is the total cost of your investment, excluding charges like advice fees. This is a useful measure to compare fees across similar investments. 

A quick note on advice fees: Many investors find that a substantial part of their investment returns goes towards paying for financial advice. At 10X, we take a different approach. Instead of offering advice, our seasoned investment consultants provide you with the facts, empowering you to make informed decisions and take control of your retirement savings. At 10X, you won’t encounter call centres– only skilled professionals who are ready to assist you at no extra cost. 

Fund Performance  This refers to the total returns you make from your investments within your preservation fund. Fund performance is determined by market conditions and your investment strategy. The fees you pay will not directly influence your fund performance, however, they will lower the returns you receive.  

Net Investment Returns  The money left over after investment fees have been subtracted from your total returns are known as your net investment returns – and it’s this net return that truly matters. After determining your net investment returns, you have to factor in the impact of inflation on the real value (i.e. purchasing power) of that return. 

For example, if you invest R500,000 in a fund with an annual return of 6%, you’d expect to earn R30,000 in a year. However, if your provider charges a 2% fee (R10,000), your net return would be reduced to R20,000. 

Now, factor in inflation: with an average inflation rate of 6% per year, the real value of your net return would be R0 in purchasing power growth, meaning inflation would completely offset the return. 

When battling the impact of inflation on your preservation fund, it’s crucial to choose a provider that offers both low fees and a transparent fee structure. Fund performance can only take you so far, and if the fees you’re paying on your investment are too high then you may fail to keep pace with inflation over the long term. This is where you’ll want to consider and compare effective annual cost. 

Effective Annual Cost (EAC)  This is a standardised metric established by ASISA to help investors evaluate the overall cost of owning and accessing an investment. It reflects the total annual expenses associated with an investment product, including fees for investment management, administration, advice, early exit penalties, loyalty bonuses, and guarantees. Registered South African financial services providers, including investment managers, have to disclose all fees. You can find your EAC, as well as the TER and TIC on your statements. You can also use online portals to check fees, and find them on fund fact sheets, which are available on the investment company’s websites. 

By reviewing and comparing EAC’s across preservation fund providers, you can assess the true cost of maintaining a preservation fund investment and opt for a provider that offers better value. In general, a lower EAC means that a greater portion of your investment is generating returns to benefit you in the long run, while a higher EAC can erode your net returns as fees accumulate over time.  

At 10X, we use strategic asset allocation and index-tracking to offer a low-cost preservation fund that consistently beats market benchmarks. If you feel you may be paying too much for sub-par returns, ask your current provider for the effective annual cost of your investments and then try out our handy EAC Calculator to see if you could be doing better with 10X.  

Asset allocation to combat inflation 

To ensure that your preservation fund investment can grow in value, it's important to combine low fees with an investment portfolio strategically designed to outpace inflation. This two-pronged approach of keeping fees low and diversifying your assets can help you grow your retirement savings and secure a stable financial future. 

It's important to spread your investments across different types of assets. For example, if you're investing heavily in property or specific stocks, you risk losing more if those investments decrease in value. The same goes for investors with multiple different investment products – for example, if you’ve purchased a preservation fund and a tax-free savings account and if both are focused heavily on assets like local stocks, you're more exposed to market downturns in that area.  

Rather than lumping all of your eggs in one basket, a smart move could be to invest in a multi-asset fund like the 10X Your Future Fund. This fund mixes different types of investments (like stocks, bonds, and real estate) across various regions and sectors. This diversification helps reduce risk because your money isn't tied to the success of just one type of investment or market. Diversification across multiple asset classes also allows you to benefit from different economic cycles and potentially enhance the performance of your portfolio. By carefully selecting and adjusting your asset allocation, you can weather market fluctuations while ensuring your investments are generating returns that outpace inflation. 

At 10X, you’re free to choose where you want to put your money – we offer diversified, highly performant funds to suit a variety of financial situations. Our various funds offer different asset allocation mixes to cater to shifting risk appetites and investment horizons. You have the flexibility to customise your underlying investment portfolio and diversify across asset classes like equities, property, bonds, and even offshore investments.  

Note: According to Regulation 28 of the Pension Funds Act, retirement annuity, pension/provident and preservation fund investors can allocate up to 45% of their portfolios offshore. 

When you invest with 10X, you can be sure that your money is in the right place (regardless of your life stage), generating returns that can help you combat inflation and secure a comfortable retirement. To chat about our underlying funds and the options available to you, reach out to a 10X consultant. There are no call centres here at 10X, so you can look forward to authentic interactions with experts in the industry. You can also read more about asset allocation and retirement savings here.