Tuesday, September 2, 2014

Annuity plans are just a function of compounded interest benefits

Today I read an annuity benefit illustration on a brochure:
40 year old male contributes 24,200 yearly for 5 years.

At age 65, he receives $2,000 per month (non-guaranteed) till 85 with a lump sum maturity of $72,000 (non-guaranteed). 

Hence the total potential return is $552,000.

The insurer has a track record of meeting its projection. Hence for simplicity sake, let’s assume above are guaranteed returns.

At the onset, it sounds extremely attractive to me. I can have an income to complement my CPF life of about $1,200 per month and about $2,000 a month I will be able to retire comfortably assuming inflation is at 0%!

However, as a discerning citizen, I tried to replicate using a balance funds portfolio of unit trust. 

Assume I purchase a balance equity fund of Fixed income + Equity. The fund is likely to be able to meet its 4.5% payout and at the same time at least maintain its NAV.

The 40 year old male contributes 24,200 per year for 5 years. Let’s assume a 3% return at 0% sales charge for the first 5 years. 

5 Years later, he would receive $128,481.

Using the 128,481, he invests for the long term at 4.5% per annum for the next 20 years. 

He would receive $309,859.

Thereafter at 65, he elects to pay himself 9% P.A and he would receive $27,887.31 yearly and after 20 years he would still receive $127,573.20, which was roughly the amount he started at age 45.

The difference? 

If he outsourced his retirement planning to an annuity product, he receives $552,000. If he does it himself diligently, he may receive $685,319 or more, assuming his investment average return is no more than 4.5% per annum. 

That’s a huge $133,319 difference!

On top of that, the DIY route allows flexibility to bring forward the pay cheque if required and still get a better return. There is no early termination charges neither is there insurance coverage though.

So what does this exercise mean? To me, it means the following

- Most Singaporeans are rich. They can afford to earn $133,319 lesser over the long term. Singaporeans are not bothered with retirement planning and putting the blame on others for having to work past retirement age. This is why the market is filled with so many retirement products that earn no more than 5% on projection basis and yet selling like hot cakes.

- The effects of compounding has been used repeatedly by annuity companies to give seemingly huge returns at a paltry investment return rate of less than 5%.

- Consider instead to contribute to SRS and CPF special account instead while investing for the long term and enjoy the benefits of compounding instead of trying to buy 1-2 products and call retirement planning a day.

- The present value of money must always be considered and discount back to present value in order to make sense of the projections you are looking at. In reality, SGD 1M at 45 years from now at 4% inflation rate is really only worth $171,200. That's probably a 2 room flat future value with a lease of 99 years. Hence receiving $28,000 yearly 45 years later is only $4793 or no more than $400 a month! 

Tuesday, July 1, 2014

My thoughts on CPF minimum sum, retirement and risk hedging

If you were to receive $155,000 and asked to stop working for 5 years, would you agree? How about stop working for 10 years?

I have written articles on retirement and income investing long enough to know that one can never solely rely on CPF for retirement. The main reason is because majority of CPF savings are often used to fund your home purchase, the OA account usually has very little left to be set aside for retirement. Hence more often than not, the minimum sum is usually what is left after property usage.

Using myself as a case study, I can work out on how much CPF is to be used for housing

I have paid about 720k for a property.

Assuming a 2.5% interest rate averaged for my home loan, I would have paid a total of $815,000 base on my current loan quantum and a loan of 30 years tenure. The total usage from CPF would be $923,000, inclusive of the 15% downpayment from CPF.  

At a hypothetical combined monthly income of $12,000, 20% to OA contribution (averaged over the working life); at the end of 30 years, nothing is left in the OA account. It is likely that I would have met the required minimum sum (at that point of time) with little excess.

The monthly payouts of CPF life provides about $1200 if the minimum sum is met. I believe for a comfortable lifestyle, at least $4,000 monthly (in today dollars) is required in Singapore. This is only about $130 a day. Hence, there is a shortfall of $2,800.

$2,800 can be easily achieved using a portfolio of $500,000. Hence it is extremely important to create a portfolio of recurring income. The larger the portfolio, the easier it is to create cashflow and the less reliant on CPF minimum sum.
Buying a home within my means also help to stem cashflow out from my income and portfolio and rely completely on CPF funds for monthly installments as long as I am working.

I am also mindful the following risk that would derail my retirement planning:

- health risks that early terminates my working life
- interest rate risks that wipe out my CPF account prematurely before my loan tenure ends and I have to cough out cash for monthly repayment
- career risk in which I lose my job in the event of a mistake, complain or economic downturn
- portfolio risk in which a global economic downturn wipes out all my gains and my portfolio drops 50% which triggers a margin call to top up funds.

Strategies to hedge against the above risks:

Health Risk: Purchasing various health term insurance to provide payouts and hospital bill coverage upon illness

Interest rate risk: Invest my excess CPF funds at higher rate of return while keeping $20,000 in my CPF OA to earn the additional 3.5% interest and paying the monthly installment at current 1% mortgage interest rate. I am prepared to redeem a significant portion of the loan when interest rates move above 2.5%. Hence I chose a floating rate home loan with no lock in and flexibility to switch to a fixed tenure loan

Career Risk: Invest in my career by constantly upgrading through studying (just completed my postgraduate), reading and meeting with professionals within the industry to ensure I am up to scratch with my cohort

Portfolio risk: Continue to take profit on my portfolio (through monthly dividends) while we are still enjoying the ride up and continue to pay down my portfolio loan using my dividends and monthly income.

Saturday, June 7, 2014

My unit trust portfolio

Throughout my investment journey I learned the importance of diversification and dividend investing. Diversification hedges against single stock/bonds mishap and over confidence in one company; dividend provides the psycological consolation of recurring income from my investments. 

Last year after much deliberation, I liquidated part of my stocks portfolio and purchased unit trust in order to diversify the systemic risk. I still hold a good number of blue chips like DBS, SGX CAMBRIDGE, OUE, Semb Corp Industries but I decided that no matter how diversified I am in local stocks, I am subjected to political and country risks. If one day the PAP is ousted from power, our stock market may take a severe beating. 

Last year, I pledged my stocks for a credit line with my then bank at 1.05% interest. Hence the unit trust you see below are partially funded by cash, ie 300k and partially borrowed.

I chose dividend payout for all my funds (with exception of USD bond funds) as I usually reinvest them at my discretion when markets are down. The markets are in a staggered uptrend mode. By opting for dividend payout in cash instead of reinvestments, I am forcing the fund managers to take profit on a monthly basis for me. There is no point for me to reinvest and keep buying higher.

After 1 year, the total dividends I have received is approximately $30,000. The capital loss on my funds works out to be 9,900. Hence the net return is 3.2%. Moreover, I incurred a interest cost of about $3150. Hence the return works out to be 2.76%. However, if you calculate base on my initial capital of $300,000, my leveraged yield works out to be 5.65%, if I liquidate everything on Monday.

At current market, I intend to hold the unit trust portfolio for the long term, possibly till retirement. The whole purpose to construct a leveraged unit trust portfolio is to lock in the contract for low interest rates (1.05%) and use the dividends to repay the loan. Technically, the loan can be repaid in about 10 years time assuming dividends remain constant. I can repay the loan anytime if I sell off my stocks anyway.

I still have about $300,000 “debt headroom” to draw down and capitalise on any market opportunity that may appear. Eg, the stock market crash 20%, I can utilise $100,000 to pick up deeply discounted stocks at low interest rates while waiting for recovery, the dividend yield will be able to pay for the interest accured.

Is it possible to replicate this strategy? Yes and no. I bought most of the unit trust from fundsupermart and transferred to the bank I was previously working. The interest rate was granted at staff rate and if you walk in to any bank for such service, be prepared for at least 1.6% loan rates and 2% sales charge.

The good thing about buying unit trust for dividend is the payment is usually prompt and gains are not taxable. This serves as good income if I am out of job but if I am gainfully employed, the dividends will pay for the loan and interest while buffing up my credit limit to draw down in the event there is a market crisis. I will opt for dividends reinvestment scheme if any unit trust fall below 10% from my initial purchase price.  

At low interest rates environment which in my view will continue for several years, borrowing money to spend/invest is the best way to hedge against zero interest rates environment.

My investment portfolio has grown significantly from the leverage. Including CPF and SRS funds, I have about 1M invested already. My cash stock dividends and trading gains works out to be about $20,000 a year which in totality brings me $4,000 passive income a month. I will work towards a 5 figure passive income in order to have a more comfortable life ahead. Still slightly away from the 50% mark, I shall persevere.

Do follow Sg Blue Chip on my investment journey.