Topic: 3 Costly Mistakes to Avoid in Retirement Planning.
Date/time: 16 September 2017 10am (SGT).
Duration: 1 hour.
Synopsis: I will be speaking live in facebook and I will be addressing the most common but costly mistakes people make for their retirement. I will also show how actual individuals plan for their retirement with disastrous consequences. Retirement planning has two parts: wealth accumulation and wealth monetisation. This Facebook Live focuses on the second aspect. Do inform anyone who may interested.
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Below is the transcript of the video:
"Hello everybody. Today I will speak on 3 costly mistakes to avoid in retirement planning. There are two phases in retirement planning – wealth accumulation and wealth monetization. This Facebook live is for those who want to know the common mistakes to avoid when they try to monetize their wealth for retirement. I am Wilfred Ling and I have been providing financial planning services to individuals for the last 11 years. Many individuals have successfully retired under my advice. I hope to share some of my expertise with you in this video. During this one hour session, I would like you to post any questions related to today’s topic in the comment box and I will try my best to answer. If you are watching this as recorded video, do post your questions at the comment box as well and I will answer them as soon as I can.
The agenda for today is the 3 costly mistakes people make in their retirement planning. I will also be showing you how people plan for their retirement. These are actual cases and they are negative examples. At the end of the presentation, there will be a call to action. You will be investing 1 hour of your time to watch this video and interact with me. Nothing has happen unless you take action and do something about it. One of the things I will ask you to do is to use free software that I have developed to plan for your retirement. Please watch the video all the way to the end so that you can benefit from this presentation.
The 1st approach is the Income -only strategy and the 2nd is Income plus Capital Drawdown strategy. The income-only strategy relies only on income of the portfolio. The aim is to preserve the capital of your retirement portfolio e.g. relying on dividends on Real Estate Investment Trust or rental income is called the Income approach. The Income plus Capital Draw down approach does not just rely on income. It relies on income and capital. It is a combination of both. You rely on your income from your portfolio but at the same time you need to do some liquidation. This is a cash flow diagram. The horizontal line shows your age and the vertical line shows the monthly income. As you can see, at the end of your life expectancy, there is a very large payout because the original capital of your portfolio is return back to you. Somewhere in between your retirement years, you get a bit of your income. Sometimes we call this the Bullet Approach because of the large payout at the end.
The Income Approach is suitable if you have a permanent dependent. i.e. you need to support someone even if you are old such as a child with special needs who depends on your income for the rest of his life. Another reason why you use this approach is because of age difference. E.g. the age difference between you and your spouse is quite large and you are the older spouse, so you need to leave quite a large bequest for your spouse. The 3rd reason is because of family business. You will need to hand over your business to the next generation and liquidating your asset is not possible. Another reason for this approach is that you have a significant amount of wealth and is able to support your lifestyle.
What you are seeing now is the Drawn Down Approach. This approach has a constant cash flow throughout your retirement years. At the end of your life expectancy, there is no large bequest so you are basically drawn down on your large cash flow. This approach is useful when you do not have any dependants and you do not need to leave anything behind. This approach is suitable for you if you like to enjoy the fruits of your labor and you are the average individual, not of high net worth. What happens when you use the wrong approach? You may have insufficient money to meet your expenditure and will not be able to support your lifestyle as your income will be very small. Another problem can happen when you plan liquidation because you do not have enough money and to sell. The 3rd reason you have to make is investment decision on how to proceed at old age because to have to liquidate your assets when you are old and decide on how to invest the proceeds. Let me give you a case study. In 2013, there was a group of retirees who live in Joo Chiat and their property was sitting on expensive land as their house was worth millions of dollars. They seem to be high net worth but were cash poor, so they sought help from the government to support them as they do not have enough money. This is the result of being asset rich but cash poor. They should use the Drawn Down approach but they were also not using the Income approach. They were just living in the property and not even renting it out for rental income.
The 2nd mistake that people often make is chasing after returns. This would be harmful to their retirement because high returns often result in high risk. Why is high risk bad when you are retired because there is a high chance of failure that is when you tend to run out of money earlier than your life expectancy. When you are retired, risk is your enemy as you do not have the money to average down when the market drops, whereas when you are working, risk is your friend. When the market drops, you are fine because you have the income to average down. One example is you have two portfolios to choose and each portfolio give you a return of 5% per annum over 30 years. One is a straight line and the other one is a highly volatile market, so you invest both. Say 1.2 million at the beginning of the period and you use the drawn down approach. If you draw $3,661 every month, looking at the two portfolios, the one with the straight line down ends exactly at 30 years but the one is volatile ends 6 years earlier. This happens because the one with the straight line has no risk at all. But the other one that is fluctuating all the time represented by MSCI World is volatile and has periods of losses where you face with a loss and end up liquidating. So the subsequent gain is not able to compensate for the earlier losses. The bottom line here is that volatility is a reason why this risky portfolio ended 6 years earlier.
I did some calculation. Assuming 5% per annum over 30 years and volatility is 11.8% which is a representation of MSCI World. You make a withdrawal of $6000 that is the drawn down approach and I use the Monte Carlo simulation to figure out what is the probability of running out of money before 60 years is up. This is really what is happening, at $1.2 million, theoretically this should last for 30 years, but it turn out that there is a 52% chance of running out of money before 60 years is up. If you put $1.5 million in the beginning, there is a 24% chance of running out of money and if you have $1.8 million, you have 10% chance of running out of money earlier. For a retiree, this risk is not acceptable because it ends at the end period of your life expectancy. I don’t think you will have the capability or ability to work due to decrease physical or mental capability at the end of your retirement. This kind of risk is not acceptable to a retiree although we are using probability to determine what the chance of success or failure is. What happens if I use the zero volatility? If you were to invest $1.8 million in MSCI world, at 5% return, there is a 10% chance of running out of money 10 years earlier. For the same amount of $1.8 million, if I invest in just 2% per annum over 30 years, zero volatility, no risk, with this computation you have 0% chance of running out of money. For a lower return, you have 0% chance of running out of money. This means that volatility is more important than returns. For a retiree who is chasing after returns is chasing after the wrong thing, returns is less important. Low volatility is what is important. If your volatility is low, your chance of having a successful retirement is higher than chasing after a high return.
Income approach is when you just consume the returns of your portfolio. You do not want to liquidate the capital so using the same perimeters I do a monthly withdrawal of $5000 of $1.2 million. If I have $1.2 million and a return of 5%, I have $60000 a year, so I just consume the return of the portfolio. My calculation shows for $1.2 million of portfolio, you still have 23% chance of running out of money because returns are not guaranteed. There could be possibility of losses. For those using the Income Approach for retirement planning, do not be too happy as there is still a chance of running out of money when you retire. What happens when you chase returns? You can run out of money when you are the most venerable, at the ripe old age. Low volatility is more important than high returns.
The 3rd costly mistake that people make is to make the retirement plan too complicated. Why is this not recommended? It is because of the risk of lack of mental capacity when you are old. When you are between 65 to 84 years old, statistics shows that you have a 20% chance of having Dementia. If you are 85 years old and above, you have more than 50% chance of having dementia, which does not include other mental and physical form of incapacity. If your portfolio is complex, you may have difficulty in managing them. Another thing is that the surviving spouse may not know how to continue with the portfolio. If you are the savvy investor but your spouse is not, when you lose mental capacity or pass on, your surviving spouse may not know how to manage your portfolio if it is too complex. Lastly is the more complicated the portfolio, the higher the chance of neglecting it instead of paying attention to it. Here is an example of a portfolio that is too complicated. Many retirees do this to certain extend. E.g. you split your portfolio into 7 buckets. Bucket 1 is the portfolio you will draw on for the next couple of years. We call it emergency cash or we put it in the Fixed Deposit. Bucket 2 will not be drawn on until 5 years later and Bucket 3 will be drawn on 10 years later and so on. The idea is Bucket 1 is for short term consumption and Bucket 6 is for long term consumption, many years later. The time horizon is different. Bucket 1 is at the lowest risk and Bucket 6 is the highest risk.
As time goes by, Bucket 2 will become Bucket 1 and Bucket 3 will become Bucket 2 and so on. In order to maintain this portfolio, you have to make sure that the risk of Bucket 2 will be rebalance to become like Bucket 1 and Bucket 3 will become like Bucket 2 in terms of risk level. It has to be constantly monitored and rebalance. Unfortunately this is not easy as you have to constantly rebalance. This model here is from a particular company that is using it for their customers. I find that this is too complex. You can outsource the management to a financial adviser to do it but there are particular issues. One of the issue is if the financial adviser is managing this portfolio in a non-discretionary basis, the adviser will need the customers approval for all the transactions so as an investor you will constantly need to make decision and cannot fully outsource. The other model is for the financial adviser to manage the portfolio on a discretionary basis, meaning that there is no need for the investor to authorise every transaction and this is done by giving the financial adviser the Limited Power of Attorney. The Limited Power of Attorney will be terminated and ceases when the investor losses his mental capacity. Once this happens, the portfolio cannot be managed anymore. This is complicated as the investor might need to appoint the Lasting Power of Attorney in anticipation of losing mental capacity. As such, it can get more and more complicated. However this entire portfolio can be combined into one. A low risk and a high risk portfolio can be combine together when the risk is low. The 7 portfolio can be combining into one low portfolio.
You may ask what the opposite of complexity is. It is not simplicity but it is automation. How do you automate? This is a model on how to automate your investment, a retirement portfolio. At the an bottom is the highly automated portfolio which is annuity like CPF Life that pays you an income every month for every year or for a period of time or for life automatically. The amount may vary depending on the Terms and conditions of the annuity like CPF Life. If the monthly amount is not fixed as it is a fraction of the interest rate and mortality experience of the CPI pool. For insurance policy that you buy annuity from a private insurance company depends on the Terms and Conditions. What can be sure is that the pay-out is automatic. There is high automation and your investment can be partially automated. Why it cannot be fully automated because all investment e.g. stocks, REITs, dividend stocks, there is corporate action that you need to do so there will be some decision making. You will need to rebalance the portfolio and so on. However, it can be partially automated; the dividend does come in if you designate the bank account. I have also don some partial automation for my clients where I forecast the amount of dividend the customer may receive in the next 12 months and I will determine how much capital need to be sold off on a monthly basis. I will set the amount at the beginning of the year and it will be applicable for 12 months. After that, the portfolio will be review again the cycle continues. I can do an automatic draw down for the investment but still it is only partial automation because certain investment decisions need to be made. The one that has the least automation or no automation is rental income. It does not automatically give you an income as you are dealing with a tenant and you need to chase after your rental from your tenant. If you have a bad tenant, you need to keep chasing for the rental payment. When the tenancy ends, you need to renegotiate or look for a new tenant, sign the contract, pay for the maintenance or repair etc. Rental income has no automation at all. My recommendation is to consider putting a larger part of your portfolio in annuity so that it is fully automated, and the smallest part in rental income. Unfortunately in Singapore, people tend to get it wrong and they do it in reverse. Their rental income is the largest because they are crazy over property and tend to put their entire wealth into property. As a result there is an overweight in property. Many people are not into annuity and they have to be forced to sign up for annuity in CPF Life. This is sad as people have poor financial literacy. The bottom line is to make sure your portfolio is fully automated.
Next I will answer some of the questions that you all have just posted. The question is “What can someone in his early 30s do to plan for retirement in Singapore?” In retirement planning, there are two phases. That is Wealth accumulation and wealth monetization. Wealth monetization means you draw down on your retirement years as you consume your asset. In your early 30s, you are on the wealth accumulation phase. You do not have much asset but you have human capital, which is the potential to make money. In this phase, there are certain decisions you make which would affect the future. The most common mistake that people make when they are in their 20s, 30s and early 40s is to go with the flow with what everybody is doing. People buy property that is beyond their means. If they are buying a HDB flat, they will go for the largest. If they are buying private property, they go for the expensive ones and leverage. They use 60% of their income because the law allows you to use 60% of your income to service the loan. When you over leverage, you will be paying a massive amount of interest to the bank, sometimes up to 50% of your interest to the bank. Two things will happen. One if your property do not appreciate by a similar amount, you would have lost money and you will be jeopardizing the account as the huge interest you are paying could be used to invest in other investment for your retirement. My advice to young people is buy property according to your means and not to go with the flow.
The next question is “Is it advisable to maximise the CPF Retirement Account?” CPF Retirement Account exists only after 55 years old, so you will see a 4th account. In the retirement account, certain amount from your special account and your ordinary account will be transferred there up to the maximum amount which varies every year. There is another scheme known as the Enhance Retirement Account which is over $200,000, which is the maximum amount. What does the Retirement Account mean to the retiree? That account will participate in CPF Life and eventually you get a monthly pay-out for the rest of your life. CPF Life is an annuity and is an important aspect in your retirement planning asset allocation. If you have a large amount of annuity, that is good. I depend on the % of how much money you put into annuity. My principle is never put all your eggs in one basket. If you have $100,000 in your bank account, you should not put all of in in a single instrument like annuity. There is also a risk in CPF Life as CPF scheme changes regularly, so there is a policy risk which you should keep in mind.
Another question asked is “Would you advise transferring money from your CPF Ordinary Account to the Special Account?” If you use your Ordinary Account to service your mortgage instalment, then the answer is No, it is not advisable as you need to use cash to service your mortgage if you transfer to Special Account. It all depends on how much cash flow you have. Many businessmen have great ideas but they go bust because of cash flow problem. If you are using your Ordinary Account to pay for your loan and you do not have much cash, then I would not suggest transferring to Special Account. However if you have sufficient cash flow, you can transfer from Ordinary Account to Special Account. This transfer is irreversible and there are risks of policy changes as CPF rules can change.
The next section is how do others plan for their retirement? I have free software at this link ifa.sg/free-passive. A few people have used it to plan for their retirement. Basically, it is a cash flow projection report to show what are their expenses and their passive income and whether there is a shortfall. Looking at the diagram, the horizontal line is the age of the person and the vertical line is the monthly amount that is needed. The individual will key in the desired expenses, the desired income he wants for retirement and what are the passive income and the inflation. This is not predetermine by me but is input by the user. For this example, from the blue line, the only source of passive income is CPF Life and the red colour bar shows the shortfall. This shows a very large shortfall which is not good. Next example shows this person has three products, CPF Life, AIA Annuity Plan and AIA Gen 3; however these are not able to meet the shortfall. Another individual shows he has done good planning, using CPF Life, Annuity, rental, dividend and interest from stocks and fixed deposits but still has a large shortfall. Another person uses CPF Life and intends to draw his CPF account on a regular basis also has a shortfall. Other examples showing a shortfall despite having a few products like CPF Life and Tokio Marine also has shortfall. Another individual looks good. He has three products, CPF Life, Tokio Marine and AIA. The shortfall happens only at the beginning from 55 years to 65 years. This means that he probable needs to work till 65 years. This person looks like he can retire but later on I discovered that he is a Financial Adviser and he is using my software to show his customer the basis of recommending two products, Tokio Marine and AIA. So this is not a genuine case.
To summarise my presentation, the first costly mistake that people make is using the wrong approach in retirement planning. Using the drawn down approach instead of using the Income approach. The second costly mistake is to chase after return which translate to high risk and increase the chance of depleting your assets earlier than your life expectancy. The third costly mistake is to make your retirement planning too complex as complexity is not good. Automation is the best and most people retirement is in jeopardy.
Now is the call to action. You have invested 1 hour of your time listening to this video on the kind of mistakes people make for retirement. Your situation has not changed unless you do something. What I want you to do is to use my free software (show link) to create a report on your retirement situation so that you have an objective way to measure how well or how bad your situation is. I will put the link in the description of this post.
If you think your situation requires some expert advice, I want you to consider the 2nd call to action which is to sign up the retirement package (show link). The link is shown on your screen but I will also put it in the description of this video post after this Facebook live has ended.
Once you sign up for the retirement package, I will help you determine how much retirement expense you will incur. I will run a simulation to find out how much CPF money you will have when you retire. I will teach you how to use CPF schemes to create multiple sources of passive income. If you are a taxpayer, I will also use Supplementary Retirement Scheme (SRS) to create passive income and save taxes. But I will run simulation on SRS first as SRS is not for everyone even if you are a taxpayer.
The instruments that I will use to create passive income also includes bonds, unit trusts, fixed term and perpetual annuities and CPF schemes. For those who want to use rental income as passive income, that can also be included with an additional top-up. The usage of using rental income to create passive income is called credit management in which I will plan and recommend the optimal loan you can afford to borrow without jeopardizing your retirement and other goals in life. As a reward for watching this to the very end of the video, here is a promo code:
35SPECIAL which entitles you to a 35% discount off my retirement planning package. This promo code will only last for 7 days.
If you have any questions, feel free to private message me through Facebook or at the contact link of my website. Remember, if you are watching this as recorded video, you can also post your questions in the comment box and I will try my best to reply to your questions.
With that, this is the end of this video.
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