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Old Mutual retirement fund warning

Old Mutual has warned South Africans against placing their ordinary or emergency savings into tax-deductible retirement funds to try to generate higher returns. 

Traditional financial advice recommends maintaining three months’ worth of expenses in an emergency fund. However, inflation erodes the value of cash, making it challenging to keep pace with rising costs. 

This pressure is what has pushed some South Africans to consider placing their savings in other investment products, Old Mutual advice manager Keith Peter explained. 

The implementation of the new two-pot retirement system has exacerbated this as the flexibility it provides has made it useful for people looking to park their emergency savings elsewhere. 

Peter warned that this strategy is risky and encouraged South Africans to think carefully before using market-linked retirement funds for this purpose. 

These funds are not designed for short-term savings. They are intended to generate strong returns over the long term, not to provide short-term immediate volatility. 

“During the Covid-19 pandemic, markets saw steep drops, leaving many who relied on their investments for emergencies withdrawing funds at a significant loss,” Peter explained.  

“This likely severely undermined the value of this money, causing many to go into debt when they needed cash the most.”

He advised South Africans to manage inflation risk by starting with a holistic financial plan that considers emergency savings, retirement savings, and insurance. 

“A realistic emergency fund should start with a comprehensive strategy considering all aspects of your financial health. This ensures that your emergency savings are aligned with your actual needs and priorities,” he said. 

Peter highlighted that adequate insurance can reduce the need to accumulate large cash reserves for emergencies, as specific risks are already covered. 

“The plan should determine how much cash is required for emergencies and what risks are already mitigated through insurance, such as medical aid, gap cover, or vehicle cover,” he explained.

“For instance, if you already have gap cover for medical expenses, there’s no need to set aside additional funds for medical emergencies.”

By clarifying these details, you can avoid ‘over-saving’ in cash reserves that inflation could erode while still being adequately prepared for unexpected events.

Only after these elements are accounted for should you select the most suitable savings vehicles, including whether to consider a tax-free option. 

Emergency fund checklist

Below is a checklist from Peter, which outlines what South Africans should think about when saving for an emergency. 

  1. Set a Realistic Emergency Fund Goal Based on Actual Expenses

Calculate an emergency fund amount based on essential expenses tailored to your specific needs. Consulting with a financial adviser can help you create a customised safety net, ensuring your fund is neither too large nor too small.

  1. Limit Cash Exposure with Proper Insurance Coverage

Review your insurance coverage, including medical aid, vehicle insurance, and gap cover, to see what’s already protected. With adequate insurance, you can maintain a smaller cash reserve, knowing that major expenses are covered.

  1. Choose Stable and Accessible Savings Vehicles

Once you understand your risks, select a savings vehicle that offers growth above inflation and quick and easy accessibility.

Avoid volatile investments, such as equities, which may experience sharp drops and are less reliable for emergency needs.

  1. Avoid Keeping Emergency Cash in Low-Interest Accounts

Holding cash in low-interest accounts, or “under the mattress,” leaves it vulnerable to inflation. Opt for a savings vehicle that balances growth with accessibility, protecting the purchasing power of your emergency funds.

  1. Reassess Your Emergency Fund Regularly

Review your emergency fund periodically, especially if it hasn’t been used for some time, to ensure it’s still appropriately sized.

If you find yourself with excess funds, consider reallocating some to higher-yield investments to keep up with inflation.

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