BT INVEST

We are lucky to be living in a country with amongst the best social security plans in the world. It covers for (i) housing, (ii) medical and (iii) retirement income. It has individual accounts (more you contribute, more you get), and is advance funded (vs. pay-as-you go) scheme, ensuring the scheme does not put pressure on the tax payer.

However, CPF is still only  expected to cover the minimum living expenses. And the numbers are lower at the higher income bands. A study by NUS shows CPF would cover 70 per cent and 63 per cent of pre retirementr income for people at medium and upper middle income. This versus a recommended 80 per cent. And the figures would be lower if people bought larger HDB houses.

 

Percentile	Starting pay (age 25)	Benchmark flat	IRR at retirement  (age 65)
			benchmark flat	Larger  flat
30th	1.820	3 bedroom	88%	56%
50th	2.500	4 bedroom	70%	58%
70th	3.300	5 bedroom	63%	48%
Source: Straits Times, A2 Nov 15 2012

Clearly people over the median income need to save more, over and above their CPF contribution, if they want to retain their standard of living. This especially given todays aspirational lifestyles (card, card and condo) – with housing having a material impact on future retirement nest and income.

Most experts agree that one will need about 80 per cent of  pre-retirement income in retirement. While expenses maybe lower on taxes, mortgage and children - medical expenses (and travel) are expected to be higher.  With investment earnings replacing salary income –experts advice on withdrawing no more than 4-5 per cent of savings each year. This would mean a retirement nest of 16–20 times of pre-retirement income. 

Assuming CPF covers upto 50 per cent of pre retirement income – one will still need an additional retirement nest of 5–7.5x of pre retirement income. Even at reasonable investment returns on savings over 30 years – it will mean a minimum incremental savings of 5 per cent (gradually going up to to 10 per cent post 45 years) – every month.

Income pre retirement   100 Income post retirement 80% 80 CPF     50% 50 Other investment income 30% 30           % withdrawal   4% 750         7.5x

 

Of course individual savings rate would vary, as would yearly returns on investments. But realistic savings goals and long term market average returns  are sufficient to achieve your goals. However, you need time (the earlier you start saving and the more you save – the better).

Critical then that all financial decisions – credit card payments, car loan, mortgage etc. be balanced with fact that you are able to save 5–10 per cent (after expenses) – every month.

Basic guidelines: (i) start investing early, (ii) invest as much as possible, and (iii) attempt to earn a reasonable rate of return.

Savings:

• Pay yourself first: set up regular monthly plans. This ensures discipline as well as allows benefit of dollar cost averaging.

Asset Allocation & Rebalancing

• Over a longer period, asset allocation has shown to be the most important factor in determining returns from investing (with stock selection and market timing having only secondary roles). Different asset classes (equities, fixed income and cash) have different risks and returns. Moreover they have low correlation to one another (i.e. performance good or bad at different times). As not to put all your eggs in one basket, it is prudent to diversify your investments across these.
• There is obviously no one asset allocation formula or strategy that will be appropriate for everyone. However as a general rule – the younger you are, the higher percentage you should have in equties. A common convention used  to determine the equity percentage of your portfolio - is to subract your age from 100 (or bond holdings equal to your age).  Another is based on time horizons:  60 per cent equity: 40 per cent bonds - for a 5 year horizon; 80 per cent: 20 per cent for a 10 year horizon and 90 per cent: 10 per cent for a 15 year horizon.
• REBALANCING: As market volatility will lead to shifts in asset allocations over time,  it is recommended to review and rebalance your portfolio on a periodic basis (annually).  Sell the asset class that has risen and now forms a larger portion of your portfolio mix, and buy the asset class that has fallen.
• In fact, of all the market techniques, this may actually get you closest to goal of "buy low, sell high".

Investments: Keep it Simple

• Diversified and  low cost index funds have the advantages of - (i) diversification, and (ii) lower costs. Focus on fees, in the investment world, you get what you do not pay for.
• Stock: If you do want to invest in "individual" stocks – one needs to educate oneself and be prepared to spend time. In stocks, you are purchasing future cash flows. Price at which you buy is as important as what you buy. Analyse companies “economic moat” and earnings. Ensure the price allows a margin of error.

Mortgage: Not an investment but a home. Try and pay back early in a prudent manner

• We need a place to live. Once mortgage is paid off, it also frees up cash flows for other expenses or savings. Beyond that, a home provides a sense of security and financial stability that money alone cannot. Most financial experts encourage buying a home and paying off in a prudent manner.
• Mortgage should not be confused with an investment. It does not provide you an income.
• As Robert Kiyosaki says: assets and liabilities are not based on balance sheets, but on profit and loss statements. Asset puts money in your pocket, while liability takes money from your pocket. A mortgage is really an liability.
• More importantly, monthly payments takes money away from your savings. You need to buy a house appropriate for your income and lifestyle and pay back in a prudent manner. While banks may allow a monthly repayment debt  of up to 35 per cent, you may want to restrict to a lower per cent if you still want to save 10 per cent  of income (post CPF, taxes and living expenses). Given importance of "time" and compound interest, it is important that you start saving early. Or else you may end up being "asset rich, but cash poor". 

Life Insurance: Sole purpose of life insurance is to replace your income in case you die, so that your family can maintain their quality of life.  Amount of coverage should depend on your and your children's age - (a) balance of working life with income, and (b) balance of years with children at home. Maximise “term” coverage.

• Insurance is not an investment. Keep your investing and insurance strictly separate. Financial planners advise paying the minimum premium for a “term” coverage, and using savings for investments (in diversified low cost index funds or ETFs). Whole life or investment policies are very expensive (with high commission to agents) and based on conservate assumptions on returns.
• Annuties are meant to to ensure a mimimum income  - to cover basic expenses - for life (irrespective to movements in financial markets). However,  you have no access to those funds - so you want to balance your portfolio to ensure you still have other assets to provide liquidity and some long-term growth. Note: Annuties are not an asset class, for asset diverification (like stocks and bonds that should account for a certain percentage of your well-rounded portfolio).

Retirement: Experts agree that one will need about 80 per cent of  pre-retirement income in retirement. While expenses may be lower on taxes, mortgage and chidren, medical expenses (and travel) are expected to be higher. With investment earnings replacing salary income, experts advise on withdrawing no more than 4-5 per cent of savings each year.

• To minimise year-on-year volatility - a prudent strategy is to limit withdrawls to 4 per cent of a three-year moving average of your portfolio value. If you need 5 per cent, to get more stability, put a rolling 5 year expenditure into more stable bond funds and the rest in equities. Each year, convert one more year of spending from equities to bonds.

Build your personal road-map:

• How much you need to to save every year?
• How much should you should have saved at your age?
• How much debt should you should have?
• Your investment plan, asset allocation and need for rebalancing, if any?
• How much insurance do you need?

1. Will:  Every one needs to have an updated will
2. Ensure your critical financial documents are updated, uncluttered, and easy to access.
3. Money is only a means to an end. Stay happy and healthy.