SINGAPORE - The investment objectives of an individual is influenced by his risk profile: that is how much of losses he can bear in a year, time horizon of investments and cash flow needs.
When planning for retirement, the time horizon of the investor generally is the time he starts investing to the age when he plans to retire. For example, if an individual is 25 years old today and intends to retire at 50, he has an investment horizon of 25 years. If he is 50 this year and intends to retire at 65, he only has an investment horizon of 15 years.
However, it does not mean that once a person retires, he stops investing altogether. Hardly so, because if he merely keeps her funds as cash, he will draw down his savings far quicker than if he had continued to invest in more conservative products - this is also known as longevity risk or the risk of outliving one's assets.
There are three main stages in life and the investment strategy for each stage differs:
First, the wealth building stage: this is from the age at which we start working until five years before our targeted retirement age.
Second, preparation for retirement: this is five years from retirement until the point of retirement.
Third, retirement stage.
The first life stage is when you should be planning for retirement.
The earlier you start investing, the better it is for you because of the power of compounding. For example, if you started at the age of 20 with a S$50,000 lump sum investment in a portfolio of stocks, bonds, commodities and some real estate (either via stocks or physical properties), and invest a further S$10,000 per annum into the portfolio, you would have accumulated S$1.64 million worth of investments by the age of 50 if your portfolio grew at a compounding average of 8 per cent a year. However, if you started investing at 40 with the same lump sum and annual investments, you would have accumulated only S$252,811 at 50, hardly enough to fund your retirement.
Start with a more aggressive portfolio if you are young
If your investment horizon is more than 10 years, you should generally go for a portfolio of investments that gives you both capital growth and cash flow (also taking into account your own risk preferences). This is because today's inflation in Singapore is between 3 and 5 per cent and keeping cash is the most definite way to erode the value of your money.
Your portfolio should naturally be more aggressive, and a larger portion of it invested into assets that beat inflation over the long run. Singapore real estate historically achieved 6 per cent returns per year, not counting that we typically borrow about 70 per cent to buy property and rental returns of 3 per cent per annum. If you account for borrowing, rental income and a mortgage rate of 3.5 per cent, you can achieve returns of about 21.7 per cent per annum. However, if you are living in your only home and do not have rental income, your return will fall to about 11.8 per cent. Nevertheless, in both instances real estate has outperformed inflation rate.
We also recommend equities as an asset class because the long run returns for equities is about 8 to 14 per cent per annum. It helps to have exposure to dividend paying equities in China, the US, Europe and Asia ex Japan in general because companies that pay dividends tend to have more stable earnings. You should look beyond equities in Singapore because different markets may perform differently and diversification helps to moderate your risks.
We also recommend investing in precious metals such as gold as they provide an important inflation hedge within a portfolio. From a longer-term perspective, the fundamental drivers pushing gold prices higher (central bank purchases, high debt levels in major economies, currency debasement) remain intact.
Finally, you should also look at incorporating fixed income instruments into your portfolio for cashflow and diversification. An aggressive investment portfolio would typically encompass 80 per cent equities, 10 per cent commodities and 10 per cent fixed income investments.
Rebalance by buying more when cheap, selling when expensive
You should try to rebalance your portfolio at regular periods, for instance every six months, or when one particular asset deviates over 10 per cent from the recommended allocation.
For example, you may start with S$80 invested in stocks, S$10 in commodities, and S$10 in bonds. If stocks falls 50 per cent and others remain constant, you have S$40 in stocks, S$10 in commodities, and S$10 in bonds. The allocation will change to 67 per cent into equities, 17 per cent commodities and 17 per cent fixed income.
In such a scenario, you should then sell 7 per cent of your investments in fixed income products and switch to equities and sell 7 per cent of your investments in commodities for equities so that the original portfolio allocation is retained.
Conversely, if stocks were to rally 150 per cent, and all other investments stay constant, your allocation will now be 91 per cent in equities, 4.5 per cent in fixed income and 4.5 per cent in commodities.
To maintain your original portfolio allocation, you should now sell 11 per cent of your investments in equities and allocate them in equal parts into fixed income and commodities. This way, you will employ the important strategy of buying low and selling high.
Switch to a moderate portfolio as you approach retirement age
Now, supposing you have done this faithfully for 20 years (you were then a youthful 30 year old), starting with an initial sum of S$100,000 and adding S$20,000 into your investments every year. Assuming a return of 12 per cent per annum, after 20 years, your investments will be worth S$2.4 million.
You may feel that you are now ready to retire in five years' time at a relatively youthful age of 55. You should now adjust your portfolio to something more moderate, such as 40 per cent fixed income, 45 per cent equities and 15 per cent commodities.
If fixed income investments continue to perform at 7 per cent per year, equities at 13 per cent and commodities at 10 per cent, then your portfolio will continue to grow by a measured 10.2 per cent per year.
If your bonds pay 4.8 per cent in coupons and equities 4 per cent of dividends out of the 10.2 per cent gains, 3.7 per cent will be derived from coupons. With investments totalling S$2.4 million, you will receive S$89,491 of coupons and dividends per year - a comfortable supplement to your retirement income.
Due to your more conservative asset allocation, in a possible case scenario where equities crash by 50 per cent, commodities by 50 per cent and fixed income by 10 per cent, your portfolio would have fallen by about 34 per cent. If you had an aggressive portfolio like you did previously, such a crash would have set your total investments back by 46 per cent.
The less your investments fall, the easier it is to recover the loss. A 34 per cent loss requires a 52 per cent incremental return to recover the initial investment, whereas a 46 per cent loss requires an 85 per cent return to breakeven. At 50 years of age, a 46 per cent fall in your investments could be detrimental, so play it safe.
Continue to invest when you retire, but focus on capital preservation and cash flow
You have finally reached retirement age of 55 and your investments have grown from S$2.4 million to S$4 million because all your dividends and coupons were reinvested. You are now ready to retire in style.
But before you do so, you should switch your portfolio from moderate to conservative, which means an ideal allocation of 64 per cent into fixed income, 26 per cent into equities and 10 per cent into commodities.
If bonds pay 5 per cent of coupons per year going forward with no capital gains, equities achieve 10 per cent returns per year of which 4 per cent is in dividends, commodities 8 per cent returns per year without dividends, your portfolio will now give you 4.24 per cent of dividends and coupons per year, or S$170,970 and 2.36 per cent of capital growth per year.
Insure against the unforeseen
On top of investments, you may wish to overlay your retirement strategy with sufficient protection for hospitalisation, critical illness and premature death. Insurance products such as a mortgage reducing term assurance will ensure that your mortgage is fully paid in case you suffer from permanent disability or premature death, allowing your loved ones to keep a roof over their heads. Also, term insurance that covers critical illness and permanent disabilities will prevent you from dipping into your nest egg for medical fees in such unfortunate events.
While planning for retirement, you should be mindful that whatever you intend to use within a year, such as money set aside for your child's university fees, to purchase a car or house, should not be invested.
Seek out a trusted financial partner
Last but not least, don't go it alone. Seek out a financial partner who can advise you at each stage of your life.
It is important to have and to maintain a relationship with a bank that has a full suite of products, and more importantly, can provide you with objective and unbiased investment advice, under one roof.
Jeffrey Ong is Head of Investment Advisors at Standard Chartered Bank