Dollar Cost Averaging Versus Lump sum investing : what wins?

Dollar cost averaging (DCA) is a fundamental investment strategy.  It is implemented by a regular savings plan (RSP) which makes it easy to allocate a fixed amount of money every month to a diversified portfolio.

Understandably, the benefits of DCA have been extolled by experts and financial institutions alike. After all, what's not to like about disciplined investing, without the destructive effects of our emotions, where we get to take advantage of the inevitable short term market price volatility - buy more units of blue chips when the markets swing downwards and yet are protected because we buy fewer units during price spikes.

The Emerging Voice of Sound Financial Advice

An article co-authored by Sam Wadia and Karen Tang published in iFAST Insight magazine's inaugural issue -

Case Study: "Before and After" comparison after restructuring the financial portfolio of a real client

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Good financial advice can make a world of difference to your financial well-being. Read on for a real-life case study of how one client actually benefited from this.

Mr. Bryan Lee (the name has been changed to ensure the confidentiality of the client), 35, is an IT manager married to a home-maker. They have two children aged 7 and 5. He earns $8000 per month (before CPF contribution and taxes). They own a 5-room executive HDB flat, a mid-size car, and are repaying loans on both. They enjoy an upper middle class lifestyle - eating out during the weekends, buying new gadgets for their home and children, and taking annual vacations. Their life's dream is to provide a good eduction for their children and to see them happily settled, while never being a financial burden to them.

Just a year ago, Mr. Lee felt like most ordinary residents of Singapore, who believed that lifelong financial security is something reserved for millionaires, and who could not foresee a clear end to their working lives. He was luckier than those who are in an even more precarious situation - those who simple believe that their financial security has been taken care of, with just their few existing insurance policies, or some randomly purchased investments, or even their expectations of subsidies from the government when they retire. Mere belief is a dangerous thing to rely on. Instead, actively knowing all the relevant facts - with professional advice - is what is required.

Over the years they had bought quite a few insurance policies sold to them by insurance agents. Some of these agents were friends and family whom they found hard to refuse. Other agents were so persistent in following up with him, he bought policies from them almost just as a form of compensation for their time and effort. Interestingly though, once they had sold such policies, these agents went almost completely out of touch. The only communication he did receive were reminders from their companies to pay his premiums and the occasional letter informing him of a reduction in bonuses.

Mr. Lee is considered to be a conservative person who had always chosen to buy the products from agents of well-known financial institutions. Besides insurance policies, Mr. Lee had also bought a few investment products from his local banks. These were almost always spontaneous decisions which were initiated by the banks' sales staff. His investments included low capital guaranteed funds and some unit trusts that were considered 'popular' back then.

In Mr. Lee's case his 'status quo' regarding his financial holdings was finally disturbed when he received yet another notice of downward revision of bonus for one of his insurance policies. This revision was blamed on 'volatile market conditions'. At about the same time, he checked on his investments only to find that many were still under performing, even after holding them for a few years.

Mr. Lee realized that he need to seek a second opinion from a financial adviser who would be able to provide him with a holistic, unbiased overview of his entire financial situation.

In the process of interviewing him, the financial adviser uncovered the following areas that were currently lacking in his financial plan:

1. More coverage required, especially critical illness & disability.

2. Premiums paid are costly for the existing coverage amount.

3. Regular portfolio review and rebalancing are required.

4. A suitable investment plan that would suit his risk appetite.

5. A savings plan for his children's education needs.

The financial adviser also conducted a thorough analysis of his present and projected financial requirements, with the aim of deriving the required rate of return which his funds would need to grow, to meet his future financial needs.

Currently, at age 35, the amount of investible funds he has is $70,000 (in liquid assets). He is able to invest $1,500 per month for the next 25 years. He would require $3,500 per month (in terms of current dollar value) during his retirement years. He intends to retire at age 60 and wishes to plan for a life expectancy of up till age 90. During his retirement years, his money will be invested in conservative financial instruments which will give a return of about 4% per annum ( a constant inflation rate of 2% is assumed).

After a thorough analysis of Mr. Lee's financial situation, the amount of liquid funds he would need at age 60, is $1,557,300.

As for the funds required for his children's education needs, in addition to a starting capital of $25,000, he is also setting aside a separate amount of $500 a month, and he wishes to grow that amount to $25,000 in 16 years' time.

To meet his requirements, Mr. Lee needs to grow his current and regularly invested capital at an approximate rate of over 7% per annum.

To achieve his investment objectives, it was recommended that Mr Lee hold a diversified portfolio of unit trusts investing mainly in global equities. Other investment vehicles such as bonds, deposits and structured products were inadequate to attain the above rate of growth over sustained periods of time.

Once his needs and financial goals had been established, the financial adviser commenced work on scouring the market for suitable plans that not only had customer-friendly clauses but which were cost effective as well. Although the companies were not as well-known as the big boys of the industry, they were very strong financially and able to pass savings to clients by quoting lower premiums, and were also able to include legal clauses which were beneficial to their clients in their contracts.

Table 1 gives Mr. Lee's existing insurance holdings - detailing the coverage he receives and the premium he has to pay. The total cash premium that Mr. Lee forks out annually for his insurance is $12,952, for a sum assured of $390,000 for death and Total and Permanent Disability (TPD) and $190,000 for critical illness. In this situation, Mr. Lee is actually "under-insured and overpaying".

TABLE 1: BEFORE RESTRUCTURING

* Excludes the single premiums

** Excludes coverage from single premium policies.

After talking into consideration the various factors listed below, the required sum assured for Mr. Lee was derived:

1. Annual premium budget

2. Critical illness treatment expenses

3. Current and future expected income

4. Number of years of income to be replaced in case of death, disability, illness or accident

5. Liabilities

The products (as listed in table 2) were recommended. It can be seen that there has been significant savings of $5,464, or 42% of the original premium, and yet the coverage has been increased by 55% for death/TPD and 216% for critical illness.

TABLE 2: AFTER RESTRUCTURING

The single premium policies were discontinued and the amount reinvested into unit trusts, due to the following reasons:

a. Single premium Investment Linked Policy (ILP) is cost ineffective for both insurance and investment purposes.

b. He did not need the protection provided by the ILP and single premium investment products because all his needs are taken care of by the new program.

c. The cash value of the single premium investment products was redeemed and reinvested with suitable unit trusts.

Endowment policies offer a rather sluggish rate of growth and this would not be adequate for Mr. Lee's retirement funding. The cost for his insurance coverage was also considered high which was why they too were discontinued and the cash value reinvested.

Mr. Lee's revised portfolio provided him with immediate benefits:

1. Insurance plan with limited premium payment term (payment will end before he retires), and yet provides sufficient coverage for life.

2. 42% lower annual premium costs.

3. Effects of the sequence of the various catastrophic events (disability, critical illness, accidents) were considered in the construction of the portfolio.

4. Greatly increased coverage amount in his working years.

5. More 'client-friendly" legal clauses in the contract

6. A comprehensive mix of products, each positioned in light of the other, versus an almost random addition of policies.

Satisfied, Mr. Lee noted that the whole process was by far a more rational approach - a simple comparison of available options in the market that matched his needs and the selection of the most ideal option vis-a-vis his resources.

The New Emerging Financial Advisory Landscape

Ever since the enactment of the Financial Adviser Act, new independently owned financial advisory firms are offering consumers with greater choice for financial advise that is not exclusively tied to any product provider (insurance or investment company). This new entrepreneurial setup ensured that client's , rather than product provider's, interests are considered first n providing holistic financial advice. As a client and consumer, it is beneficial to know that the wider choice available can make your hard earned money work harder, if you choose discerningly.

What You Should Know about CPF Life

As medical science advances and with an increased emphasis in a balanced lifestyle, Singaporeans are expected to live longer with females having an average life expectancy of 83.2 years and males an average of 78.4 years. Living longer in turn means that one needs to be financially equipped to sustain his/her living expenses.

It is with this in mind that the CPF Board came up with the CPF Life scheme consisting of 4 options for CPF members to choose from – Life Basic, Life Balanced, Life Plus and Life Income. The CPF Life Balanced is the default selection if one does not specify any plan.

Though it is compulsory for everyone who turns 55 in 2013 to opt in, this does not mean that the CPF Life is the only solution available for one’s retirement income needs.

Let us first take a look at the features of the CPF Life scheme.

Who can join CPF Life

• Those age 52-54 and age 55 and above in 2009 can opt to join CPF Life (not compulsory).
• Those age 51 and below will automatically be enrolled in the Life Balance Plan if they have $40,000 in their Retirement Account (RA) at age 55.

CPF members cannot commit more than the prevailing minimum sum into CPF Life.

The entire RA account up to the minimum sum will be used for the CPF Life. Once a plan has been chosen, it cannot be changed.

Attributes of CPF Life

• Monthly payout is not fixed - The payout will be adjusted based on the CPF interest rates and the mortality experience. CPF, however, mentioned that the adjustments will be small.

• Monthly income level - The CPF member needs to consider the income amount he/she wants to receive monthly. This has a direct impact on the bequest amount for the beneficiaries.

• Bequest amount (benefit left for beneficiaries) - The higher the monthly income, the lower the bequest amount and vice versa.

• Females will receive lesser amount than males

To put it simply:

How CPF Life Works

2 components to CPF Life – Retirement Account (RA) savings & Annuity

The entire RA savings will be used to fund the CPF Life scheme. This savings is split into a pot consisting of the RA and another pot which pays the annuity premium. The split between the RA and annuity premium depends on the age of entry into the plan.

For example, for a 55 year old male, the split for Life Balanced is 70% RA and 30% annuity premium.

• For Life Basic, it is 90% RA and 10% annuity premium.
• As for Life Plus and Life Income, 100% goes into the annuity premium (as payout starts at drawdown age).
• More will go into annuity premium for the older folks who join before 2013.

Why is this split of significance?

The reason is this:

• Interest earned in the RA will be accrued in the RA and the interest will be given to the beneficiary upon the passing on of the CPF member.
• Interest earned on the annuity premium will be contributed towards the annuity fund which pools interest from other CPF members – this interest is not payable upon death.

What do beneficiaries get upon death of the CPF member?

• For CPF Life Basic, Balanced & Plus: Unused RA savings plus the premium for the annuity less any payout.
• For CPF Life Income: This plan does NOT provide for any refund even when the CPF member passes one before any payment has been made.

Note: Amounts are estimated based minimum sum $100,000 of male age 55 with deferred drawdown till age 65. CPF interest rates are assumed at levels of 3.75% and 4.25% (Non-guaranteed).

What does all this mean before you sign up for CPF Life?

• CPF Life payout is fixed around the same levels
  It is not pegged against inflation, hence, the value of payouts will shrink over time as prices of goods rise.
• CPF Life payout is not guarantee
  It is dependent on market conditions. It will be reviewed every year based on CPF interest rates and mortality experience - if CPF interest rates decrease, the payout and bequest amount will also reduce.
• Limitation of CPF Life Income option
  It does NOT pay out any money to the beneficiary should the CPF member die before payout starts.
• Variable payouts and bequest amounts
  Higher payouts mean that lesser or nothing is left for beneficiaries
• Interest earned
  Interest earned from the annuity of CPF Life Plus plan is distributed to a common pool

Knowing the difference between CPF Life & a Participating Annuity

The CPF Life Income option though gives the highest payout is not suitable for everyone. It must also be chosen with caution as it does not leave anything for your beneficiaries. Not only that, there is no refund option upon withdrawal from the scheme.

In conclusion:

• You should not depend on CPF Life to meet all your retirement funding needs as the payouts may not substantial.
• The best thing to do today is to save more and plan your retirement early.
• You can also consider additional income plans like participating annuities from insurers.
• It is also critical that you have adequate medical and insurance coverage in your retirement years.

CPF Life is our last line of defence against outliving our resources. Plan early for your future lifestyle needs and you can enjoy a worry free retirement.

Don't Leave Retirement to Chance

More and more Singaporeans are facing the grim reality of retiring later or lowering their lifestyle expectations when they call it a day. This is because they have not planned or failed to plan early enough for their retirement.

The fact is a majority of Singaporeans are unprepared for retirement. And ignorance is not bliss here.

Here are some factors to consider when planning for your retirement:

1. Retirement age

For a start, determine the age you hope to retire. The earlier you do this, the more time you have to plan and to adjust to or accommodate any hiccups along the way. Having this number in view is important as you can then project the savings you need at the start of retirement.

2. Years in retirement

Life expectancy has increased. In Singapore females have an average life expectancy of 83 years and men 78 years. You should also take your family’s medical history into account. The longer we live, the more resources we will need. The worse scenario is to outlive our resources and have no one to depend on.

3. Income needed in retirement

Most people think they will spend much less during retirement. But with plenty of time on your hands, you would not be sitting at home and not be doing anything. This is after all your golden years and you want to be able to enjoy the fruits of your labour. Giving yourself a retirement income that is 70 per cent of pre- retirement income is reasonable. To go any less would mean that you have to live a simple, even frugal lifestyle.

4. Consider inflation

Inflation is the increase in the general price level of goods and services. It can affect the purchasing power of your money. For example, with an inflation of 3%, $1,000 today will only have a value of $642 in 15 years’ time. Do not overlook this as you would not want to suffer from a shortfall during retirement.

5. Financial commitments

Consider what your likely monetary commitment would in retirement. Would your house be full paid off by the time you retire? Would you need to support your children in their tertiary education? Are your parents dependent on you? Thinking through would enable you to have a clearer picture of your retirement needs.

6. Medical expenses

High medical costs in your later years can leave you financially drained, jeopardizing your retirement. Therefore, it is highly advisable that you consider a comprehensive medical insurance plan. In this respect, when working out your retirement income, do remember to include the premiums of medical plans and other insurances that you would be paying beyond your working years.

7. Leaving a legacy

If you wish to leave an inheritance to the next generation or bequest an amount to a particular charity, this would also affect the way your retirement portfolio is structured. In either case, you would need to make provisions to ensure that the earmarked assets would not be drawn down as your retirement income.

8. Existing assets

Consider your existing assets and any future income streams when working out your retirement numbers. You can, for instance, project the value of your CPF. When in doubt, be conservative in your projections.

Investing in equities is still the preferred option to beat inflation. Equities tend to produce positive returns over the long term. Another instrument that you can consider is annuity which provides a constant stream of income for life.

Two things to remember when investing for your retirement:

• Never put all your eggs in one basket.
• Do not risk more than what you can afford to lose.

Can You Afford to Retire?

Why the need to plan NOW?

Singaporeans are living longer, thanks to the advancement in medical science and the standards of medical care in Singapore. Life expectancy of women is now 83 years old and for men, it is 78 years old.

With this longevity comes a problem – we could outlive the resources that we have in our retirement years.

A startling result from a new survey by global financial services firm Russell Investments revealed that half the working Singaporean population has yet to make financial plans for retirement even though 3 in 5 wish to retire by age 60. This is just 2 years shy of the statutory retirement age of 62. This survey was done with 500 fully employed Singaporeans aged 35-55 for their views on security in retirement (Business Times 23 April 2010).

In another study by HSBC, it found that 91 per cent of Singaporeans do not have any idea what their retirement income would be and only 9 per cent are prepared for this phase of their life (The Sunday Times, 2 August 2009).

This reflects a lack of awareness of the importance of planning for retirement and the social, emotional and physical impact of working longer. The amount is bigger than you think!

To give you an idea how much one would need in their later years:

Take for example – Mr & Mrs Lim are age 35 now and they both wish to retire at age 55. Combined, they estimated they would need a monthly income of $3,000 (in today’s dollars). Using an inflation rate of 3%, the monthly income would swell to $5,418 in 20 years’ time. And with a retirement duration of 25 years, their retirement funding works out close to $1,100,000.

And, may I add, this is assuming a simple lifestyle with perhaps a regional vacation once a year, no spending on luxury items and eating at restaurants not more than 2-3 times a month. The amount needed in retirement is a lot bigger than we think! Like it or not, you got to be a millionaire to retire.

Another alarming finding from the survey showed that:

• The average age Singaporeans start to embark on retirement planning is 59
• Only 40 per cent plan to develop a comprehensive retirement plan
• 20 per cent plan to consult a professional financial adviser
• A majority of the respondents replied that their financial preparations include setting aside fixed savings, CPF and purchasing medical insurance.

In a report by Straits Times dated June 2007, it said that only 4 in 10 active CPF members – those earning an income and who turned 55 in 2005 – had the Minimum Sum of $90,000 in their CPF at end of 2006.

Some questions you need to ask yourself:

• Do you think savings & CPF are enough for one’s supposedly golden years (after showing you the calculation above)?
• Are you willing to compromise on your retirement lifestyle and live on a lower income?
• Do you intend to continue working beyond age 62?

If the answer is ‘no’, my friend, the key then is to start retirement planning early.

The 20 something’s think they’ve still got time to plan for retirement so they postpone this aspect of financial planning often to when they’re in their 30’s. In my observation, the mid 30’s is the time when most people, in the midst of paying for a property and saving for children’s education, start to give some thought to their own golden years.

Remember, time is your friend. The earlier you start, the higher the chance that you’ll be able to achieve your retirement goals.

Reverse Mortgage - Does It Really Work?

What is reverse mortgage?

It is a scheme to provide financial security to retirees. It is an option to help the elderly to unlock the equity in their property so that they can enjoy an income stream in his retirement years.

The loan is repayable when the property is sold, usually upon the death of the borrower or expiry of the mortgage tenure. Reverse mortgages help homeowners who are asset-rich but cash-poor to stay in their homes and still meet their financial obligations.

However, you have to exercise care to the terms and conditions. According to the article titled “Couple Sue Over Reverse Mortgage” published in The Straits Times on 28 July 2009, the point of contention is the market valuation of the property.

Mr and Mrs Chua's landed property was valued at S$2.1 million in 1997 and they were allowed to borrow up to 80% of its value. But after the SARS crisis in 2003, the valuation of the property dropped to S$1.1 million. This alerted NTUC Income as the loan amount had crossed the upper limit of 80%.

The original valuation in 1997 helped secured the couple's S$2,000 per month income benefit in 2004. In 2007, it was reduced to a miserable S$300 per month. Before signing the deal, the couple was advised by lawyers about the terms and conditions. So what went wrong? Assuming they understood the 'risks' involved, NTUC Income did not seem to have done the wrong thing here.

There is some missing information in the article. Nonetheless, there are a few lessons to from this unfortunate incident.

Don’ts

• Do not depend completely on a reverse mortgage to provide you with a constant income stream.
• Do not borrow the maximum allowable limit of 80%. Go for 60%-70% instead.

Do's

• Peg the valuation of your property to a value that is more realistic.
• Understand the pros and cons of the term-based plan and annuity-linked plan – the monthly payout for the term-based is higher than the annuity-linked based; the latter gives the assurance that payout will be for the rest of your life though it is lower.
• Plan early for your retirement – the 30's phase is where most people have a greater savings capacity.
• Diversify your investments – the wise saying of „not putting all your eggs in one basket? holds true in all circumstances, regardless of whether the market is up or down.
• Discuss with your family members before taking up a reverse mortgage.

Reverse mortgages do work but you need to be realistic in using this approach to fund your retirement.

Term Life vs Traditonal Whole Life

When buying insurance, many people only go for traditional whole life plans. I’ve come across clients who have as many as 4 such plans and still be under-covered!

In planning, I would normally recommend only 1 whole life and the rest of the protection is taken care of by term plans including Disability Income Plan and a comprehensive medical plan.

Traditional whole life plans appear attractive with the monies at maturity being more compared to the latter. But term plans are the best tools to boost one’s coverage. Here are reasons why term plans are ideal for increasing your cover without breaking the bank:

1. Term plans cost much less than traditional whole life insurance. For a male (non-smoker) aged 35, a traditional whole life plan with S$100,000 sum assured (for death or total & permanent disability) will cost about S$2,186 p.a. whereas a whole life term plan (coverage till age 90) will cost only S$863 p.a. That is a difference of S$1,323!
   
   
2. By restricting yourself to traditional whole life plans, you are likely to be inadequately covered due to budget constraint. By going the term way, there is a stronger likelihood of being fully covered.
   
   
3. You can keep protection costs even lower as term plans allow you to limit the actual term coverage to an earlier age like 60. Most of us have much reduced protection needs by age 60 as our mortgage will be fully paid up and our dependents no longer need our financial support.
   
   
4. You can also terminate term plans at any time when there is no longer a need for certain protection, without worrying about the potential loss of savings.

Besides reviewing insurance portfolios with multiple whole life plans, clients also tend to have multiple Investment Linked Plans (ILPs).

A guiding philosophy in my financial planning practice is to separate investments from insurance.

ILPs are infamous for having 'hidden' charges and fees that are not fully explained at the point of recommendation by the insurance agent. Some agents are not even aware of the list of charges and fees deducted via units from the account. Ask them about mortality charges (that eat into the investment returns), and they will draw a blank look. I'll explore the pros and cons of ILPs in another post.

When you invest in pure unit trusts on your own, instead of through an ILP insurance plan, you will generally achieve better returns over the long term. You can also:

• Have access to many more funds available in the market
• Create a proper asset allocation strategy based on your risk profile
• Stop and start investing at any time (to cope with events like retrenchment or unexpected high expenses)
• Change the amount to be invested (when income levels change)
• Change investment managers (when you feel your existing manager is not performing to your expectations)

Therefore, it is wiser to separate the two needs (in most cases) - protection and savings needs. We buy insurance to protect ourselves and our families. We invest to build our future funds and for our children's education.