Money makes the world go round, so goes the saying. Most of us spend a good part of our days thinking or doing something to make more of it.
So how much money do we really need? Surprisingly enough, that is the million dollar question and the answer of which so many of us have no clue about, or worse, have the wrong idea.
This article is not intended for those fortunate few who already have all that they will ever need nor is it for those who know exactly what to do to get what they want.
This piece is for the remaining 98% of the population - the average citizen who earns a salary, supports a family, and aspires to secure his retirement. And, with luck be healthy, wealthy and free enough to fulfill some of his dreams. (Who hasn’t thought of owning a beach-front bungalow or a snazzy sports car or even a yacht?) It is also for those who wish to grow their money, rather than work hard for every dollar.
So how does the average individual make it? The answer, discussed in this article, is deceptively simple.
So why do so many people not make it? Why is it that a majority of Singaporeans are living with a financial time bomb (often without even being aware of it)?
The answer points to three insufficiencies:
1. Lack of essential yet basic financial knowledge (and it is not rocket science)
2. Lack of implementation of that knowledge
3. Simple lack of time (yes, in this case, it can be too late)
Assuming you have enough time and you are adequately insured, this very article can be the start of your financial freedom.
So, where do you begin?
My first recommendation would be for you to consult with a competent and trustworthy financial advisor. I do not recommend leaving all decision-making to him or following his suggestions blindly (a good financial adviser would naturally involve the client as well as educate him at every step of the process). It is exactly like visiting a physician with regards to your health.
With the financial adviser, one must arrive at a comprehensive and consolidated report which clarifies what your current situation is (assets, liabilities, policies etc.) as well as a precise dollar amount that you need the day you retire and how much you need to save every month now in order to reach the above financial goal.
Example:
Consider Mr. Tan, aged 40, married to a homemaker and has two teenagers. He wants to retire at 62 and we assume that he has a life expectancy of 88 years. His income is $5,000 per month and he manages to save $500 each month. The total current savings (cash, investments & CPF) is $150,000. Inflation rate is 2% per year. He foresees he will need $3,000 per month (in today's dollars) during his retirement years. We are assuming he is adequately insured.
Scenario A
If he invests his money with a bank, he would get about 1% per year.
Scenario B
If he invests his money in good bond funds, he would get at least 4% per year.
Scenario C
If he invests his money wisely in a balanced, high quality portfolio (as explained below), we can safely assume he would potentially achieve 8% per year.
Table 1 – Comparison of Rate of Return
As is evident from Table 1, the key to achieving financial freedom is the investment rate of return.
So how is this rate of return achieved?
Well, the good news is an 8% - 10% return in the long term (5 years and above) is not out of reach for the average investor. A clear evidence of this assertion is that over 1926 through 2004, investing in the biggest US stocks, would have yielded an average return, with all dividends reinvested, of 10.46%! (Source: StandardAndPoors.com). This includes all the biggest crashes in the US markets.
More Good news: Over the last two decades, the rate of return has become even higher… close to 13%.
Figure 1 shows the Dow Jones Industrial Average from 1929 through to the present. We have considered the US stock market since it is the biggest, most mature and most influential market in the world.
Figure 1 - Dow Jones Industrial Average historic performance
Now, instead of simply throwing your money at some stocks, a simple strategy, when implemented over time, gives even greater returns while reducing the volatility dramatically. We call this the ‘magic portfolio’.
Simply park your investable cash into a portfolio comprising of a split of good bond funds and selected equity funds. The ratio of the split (usually 50:50), is based on your risk profile (your FA should help you with both: suggesting quality funds as well as your ratio).
The next step is vital and that is rebalancing.
What this means is simply to re-set the ratio of the equity and bond components of the portfolio periodically. Every 6 months is ideal. All the investor must do is that if the equity component is higher, he sells some equity and buys some bonds and vice versa. The effects are shown in Figure 2.
Figure 2 - Rebalancing
This strategy takes advantage of the fact that bonds give slow growth but lower volatility where as equities tend to grow fast but with sharper ups and downs.
Besides reducing portfolio volatility, this deceptively simple step automatically “buys low and sells high”.
Coupled with that, the investor can use another powerful strategy called dollar cost averaging (DCA). DCA simple means investing a fixed amount of dollars every month or so in bonds and equities in your ratio. This automatically facilitates buying less when the price is high and more when low, and is ideally suited to the salaried person.
Finally, the key aspects that the investor should always remember are:
1. Take a long-term perspective
2. Ensure liquidity of your investments, so that you can get your money when you want it without losses or penalties
3. Have enough diversification across asset classes and geography.
4. Evaluate the quality of your portfolio, i.e. growth prospects of each individual investment
We in Singapore are lucky to have an abundance of excellent unit trusts (also called mutual funds) which give us all the flexibility, liquidity, and convenience, plus some very competent fund managers who are able to consistently beat the markets they invest in. What’s more, unlike stocks, the government allows you to invest all your CPF holdings (after setting aside the first $20k in OA and SA) into unit trusts. So take action & start getting rich now!
