Archives for posts with tag: financial freedom

I can safely say that almost everyone reading this blog would like to reach financial independence and retire early if they could. In recent years, this has caused many people to jump on the Financial Independence Retire Early (FIRE) bandwagon. There are also plenty of people who have probably given up on retirement.

Recently, I saw a post on Investment Moats on the exact same topic. The question was one that most people probably have — Can I afford to retire on $X of net worth?

The problem with such questions is that everyone’s situation is pretty unique. Not all people are married, not all people have kids, not all people have to the same number of kids, and not all people want the same lifestyle. This is why financial advisors still have their place in this day and age because some judgement is needed to assess a person’s financial circumstances.

At the same time, I thought that if there’s a benchmark or a guidepost for people, that would be a goal that people can work towards. I saw a fantastic post on Reddit that used average household expenditures to determine financial independence.

So I thought, ok, why not use data from the Department of Statistics Singapore to determine the average expenditure per person and the net worth needed to generate that annual expenditure.

I found data that separates average household expenditure by residential property type and what I did was to take the average household expenditure, divide it by the average number of people in a household and multiply it by 12 to annualise it. Then I took that expenditure number and multiplied it by 33.3 and 25 respectively to show what net worth you need to achieve FI if you’re an average person.

Here are the numbers:

Avg. Monthly Expenditure (by household type)* FI AMOUNT (PER PAX) 3% FI AMOUNT (PER PAX) 4%
TOTAL** 4724  $         566,880  $         429,455
HDB 3831  $         459,720  $         348,273
CONDO 8000  $         960,000  $         727,273
LANDED 10409  $      1,249,080  $         946,273

The nice thing about this table is that it determines what net worth you need relative to the average kind of living standard you want. For example, if you want to live like a person in an average HDB household that spends $3,831 per month, you would need a net worth of between $348,273-459,720 if your withdrawal rate is 4% or 3% respectively.

Please be aware that the table above shows us the average net worth needed per person. If you are the sole breadwinner in your household of two, then you need to multiply those net worth numbers by two.

Of course, doing so makes it seem more challenging and you might question if you’ll ever be able to retire but keep in mind that the average household expenditure need NOT be your expenditure. You can always spend much less than the average person. Life is not a game about trying to see whether you can buy more things than the next person.

This simple exercise should help give you a target to work towards but take not that it’s not scientific in that the numbers are absolute. Rather, they should serve as a guide and adjustments should be made to cater to your own situation.

 

Notes:

*The data is from the 2012/2013 Monthly Household Expenditure survey. To bring it up to today’s numbers, you would have to factor in the inflation rate for the last few years. Do not that inflation rates tend to be different for different income groups so use the right rate.

**The ‘TOTAL’ group includes households whose residences are not part of the other three categories. e.g. Non-residential shophouses etc.

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In 2013, I wrote this piece ($100,000 before 30) that highlighted an article written in The Straits Times on how realistic it is for someone in Singapore to amass $100,000 before turning 30.

More than a few people in Singapore have already proven that $100,000 by 30 is more than possible (for example, see here). What I thought I’d explore is the possibility of that same person reaching $1,000,000 by 60.

Why 60? Because that’s slightly before the official retirement age in most countries. In fact, the official retirement age is probably going to be 67 or 70 for someone in my generation. However, most people feel that they don’t have enough money to retire on even after working for a lifetime.

I want to show that’s not true.

Of course, a million dollars will not be the same in 30 years as it is today but I think for many people, a million dollars is still a sum that seems unachievable even after a lifetime of work. We’ll also look at the scenario where purchasing power is retained.

Anyway, I want to look at the possibility of a 60-year-old obtaining $1,000,000 because  $1,000,000 for a 60-year-old is kind of the same mental block that $100,000 might be for a 30-year-old.

Starting assumptions

Using the numbers from the “$100,000 by 30” article, I’m assuming the following:

Starting sum at age 30: $122,919
Savings per year: $22,805
Years to compound: 30

The article assumed that the hypothetical person saves 50% of his/her income. For the sake of easy calculation and to be conservative, I’m going to assume that the amount of savings will not change. i.e. the hypothetical person continues to save only $22,805 per year from age 30-60.

Scenario 1: $1,000,000 by 60

Using a trusty financial calculator, I found that with the above assumptions, one only needs a rate of 1.24% p.a. to reach a million dollars by the age of 60.

1.24% per annum for the next 30 years.

Let that sink in. That is a seriously low bar to cross. As I write this, the 30-year Singapore government bond has a 2.88% yield. Assuming rates don’t change much, the latest issue of the Singapore Savings Bonds which everyone loves will also get you there if you keep your money in it for 10 years and repeat the process another two times.

Scenario 2: Retaining purchasing power

Of course, those worried about losing purchasing power to inflation will point out that $1,000,000 today is not the same as $1,000,000 thirty years later. Well, historically speaking, inflation has been roughly 2.5-3% per year. This means that our 1.24% p.a. needs to be something more like 3.74 – 4.24% p.a.

Scenario 3: Becoming an actual ‘millionaire’

In order to retain the purchasing power of a millionaire today, that rate of return needs to be higher. Assuming an inflation rate of 2.5% p.a., $1,000,000 today will be equivalent to about $2,097,567.58 in 30 years. In order to become the equivalent of a millionaire in 30 years time, our $100,000 by 30 person will need a rate of return of 5.12% p.a.

Keep Calm and Continue the Process

Of course, scenarios 2 and 3 are the goals we should be aiming for and that’s not going to be achieved with government bonds but neither is it an unrealistic rate of return. The $100,000 by 30 article assumed investing in a 60/40 stock/bond portfolio which should easily give us 5% p.a. It may not get you to scenario 3 but it won’t be far off.

My point is, for many people, being a millionaire seems like a pipe dream. It isn’t. Not in both nominal or real terms.

If you’re one of those that already hit $100,000 by 30, this post of mine is to provide some comfort to keep doing what you’ve been doing. What you’ve been doing is right, and you’ll be just fine. In fact, if you can bump up the savings rate or get higher returns, you can get there is fewer years.

Now, if you can’t even amass $100,000 before 30, then what are you waiting for?

If so, you won’t take kindly some of the points made in Exhibit A below.

I recently came across this article* aimed at complete beginners on investing and it’s just downright terrible. The sad part is that I’ve seen many people share this on social media like it’s good advice to take.

I hope you didn’t take too much of it seriously because there’s plenty that’s wrong with it and any financial blogger worth his/her salt should be able to point out what’s wrong with it.

Let’s take a look at what’s wrong with it.

 

Exhibit A – a community-sourced article which has gone viral

badAdviceExhibitA.JPG

The whole article gives you four different options but doesn’t highlight the proper risks and rewards or evidence to back up its claims. In other words, it’s shit.

What Exhibit A gets right

Exhibit A starts off on the right note by asking people to invest monthly. It correctly states that for all investors, inflation is one of the things we need to beat and that by putting your money in a savings account, you won’t be able to beat inflation. In other words, people who save money in their bank account is going to see their savings buy them fewer things in the future.

 

What Exhibit A gets wrong or ignores

#1 DCA may not be the answer

While the article makes some attempt to tell us NOT to time the market, it’s recommended solution is to dollar-cost average (DCA) into the asset class. Where this goes wrong is that the market, on average, goes up more times than it goes down. What this means is that as your DCA into the market, you end up paying a higher price, on average, for the asset.

Now, being in cash runs the risk of losing out on returns from dividends, coupons or capital gains but DCA-ing into a higher price doesn’t strike me as particularly intelligent behaviour either. I don’t have the data so I don’t have a definite opinion on this but the risk of DCA should be pointed out instead of being hailed as an optimal solution to the problem.

#2 How do you define risk?

The article then classifies the different recommended “ways to invest” according to risk levels.

The problem is: what is ‘Risk’? Is it fluctuations in price levels? Or is it a permanent loss of capital?

Unless you define risk properly, the classification is unnecessarily arbitrary.

Investors with a long time horizon shouldn’t be worried about fluctuations in prices and be more concerned with the long-term returns from the various asset classes. In fact, studies have shown that over a sufficiently long period (such as 15-20 years), stocks have delivered only positive returns.

Of course, investors had to live with the volatility of prices going up and down but with a sufficiently long period, returns were both positive and higher than any other asset class. On the other hand, bonds returned less than inflation over the same period.

So which is riskier? Stocks or bonds?**

#3 Fees matter and funds underperform

The article also suggests that funds are riskier than the global ETF that the three robo-advisors invest in.

Why? Once again, no mention of that.

I’ll tell you why. The biggest reason is that actively-managed funds then to charge higher fees and end up failing to beat their benchmarks. Check out this statistic that from research that was published last year.

Over the last 15 years, 92.2% of large-cap funds lagged a simple S&P 500 index fund. The percentages of mid-cap and small-cap funds lagging their benchmarks were even higher: 95.4% and 93.2%, respectively.

Source: MarketWatch

Once again, no mention of this even though this was one of the recommended steps.

 

Exhibit A sucks

Yes, I understand that the article is for beginners but beyond telling them to save money and giving them the steps to start investing, the article doesn’t help much.

In fact, if I were to tell beginners something, it would be to understand compound interest, gets a sense of market history, and understand valuations. If you aren’t prepared to do all that, you won’t have an idea what to do when you see your portfolio fall by 30-40% or your losses (on paper) go into six-figures.

Exhibit A is that the kind of stuff that fulfils the adage of how knowing a little can do a lot of damage. Go do yourself a favour and actually read up on proper investing before you do anything.

 

Notes:

*Not providing a link to Exhibit A because it’s rubbish that you’re better off not reading it. If you’re really interested, go google the headline.

**Astute readers will also point out that the question depends on whether you are an older person without a job and a need for income to meet daily expenses or a young person with a relatively stable income and expected extra years of life (and thus, investment horizon) of possibly 40-60 years.

 

I met a friend for lunch and he shared with me that he was thinking of retiring early. Not super early but earlier than official retirement age kind of early. Given that the official retirement in Singapore is 67, he was looking at something like 60. His wife also brought up the possibility of reducing the number of hours of work or stopping work altogether in order to spend more time with their young children.

Some background first

My friend is also a colleague. He’s a very dedicated and hard worker, wife and he are in their 30s, they have two young children and are basically, in terms of income, are what Singaporeans would call middle or upper-middle class. After all, when they got married, he was forced to buy a property from the resale market as their combined income already exceeded the cap that qualified people to buy a subsidised apartment from the government.

In my opinion, that’s a big handicap for him as far as retirement is concerned as he has a 20-30 year (the typical length of a mortgage in Singapore) mortgage to pay off on his property. If he plans to keep staying in Singapore, that’s money that he’ll have to pay off as he’s working towards gathering more assets that can replace the income he receives from work.

He also has two young children. That’s an additional financial burden for roughly the next 20 years of his life. The burden should ease somewhat as his children move into primary school as formal schooling in Singapore is heavily subsidised but as far as living expenses as concerned, that’s going to be another anchor tied to his feet. But given the circumstances, it’s no wonder we Singaporeans aren’t producing enough babies to replace ourselves.

The path to early retirement

He then shared that he came across a roadshow from our national pension system, the Central Providend Fund (CPF) and was seriously considering moving more funds into his Special Account (SA) as it earned a much higher interest rate (4% as of writing) as compared to the Ordinary Account (OA) which only pays 2.5% (once again, as of writing).* He also felt that CPF Life scheme, which is basically an annuity that pays you a certain amount each month for as long as you live, was promising. He also shared that he thought about moving abroad in later years as each dollar could be stretched much more in other countries.**

Unfortunately for my friend, his housing loan will probably mean that not much is going to accumulate in his CPF account. I suspect he’ll be lucky to have about $100,000 in his CPF accounts (OA plus SA) by the time his housing loan is paid off.

I don’t envy my friend’s position. He and his wife may belong to the upper-middle strata of society if we go by household income but the fact that he has a huge housing loan on a private property and two young children to take care of means that even something like retirement may be a concern for him.

My reply

So what I told my friend must have been a paradigm shift for him because I told him that I wasn’t going to wait until I was anywhere near 60 years old. I was going to stop work as soon as I hit my target net worth that would generate enough income to allow me to live a life near my current standard of living. By my estimates, this will take me another 5-10 years. I’m pretty sure I’m an outlier because very few people in Singapore are planning to retire in their 40s.

The sad thing about us having that conservation is that if we, middle to upper-middle class Singaporeans are having this conversation, then people who fall below the middle in terms of household income better hope that their bodies and mind never give way until the day they die because they’ll probably be working for the rest of their lives.

Personally, my plan hasn’t changed. If you can figure out how much you need each month, multiply it by 33 (if you’re conservative) or 25 (if you’re less conservative) and you’ll know how much you need in order to retire. If you want to be more precise, I’ve written about this before.

The other key to this is to be able to generate at least 3-4% return per year (not difficult) on your assets which will provide the income to replace the income from work. The other concern is inflation which means that the ideal rate of return is not 3-4% but more like 6-7% per year (still doable even without leverage).

An example

Just for illustration, let’s suppose that someone in Singapore needs $1,500 per month in order to survive. Assuming $250 a month for utilities, internet and phone bills, conservancy charges and transportation, that leaves our hypothetical Joe with about $40/day for entertainment and food. Food is pretty cheap if you don’t eat out at expensive restaurants every single day.

So given the above estimate, hypothetical Joe will need anywhere from $450,000 – $600,000 (depending on whether you use a 3 or 4% withdrawal rate) in order to generate the income needed for survival.

I guess a good rule of thumb would then be that if you have double the survival amount, you would be living decently and if you have double that, you would be able to live pretty luxuriously.

In short:

Standard of Living      Wealth Needed                 Income Generated (Monthly)

Survival                        $450,000 – $600,000          $1,500
Decent                           $900,000 – $1,200,000       $3,000
Luxury                          $1,800,000 – $2,400,000    $6,000

Next steps

I know that those sums above look ridiculously huge but if you plan to retire without worries, that would be the kind of sums I would aim to have to retire with a peace of mind.

Of course, if you can cut your expenditure down to much less (e.g. through growing and cooking your own food, spending much less on discretionary items such as cars and holidays, spending less on medication and healthcare by keeping yourself healthy), then I guess it’s possible to retire with much less. The other alternative would be to continue working in some form (i.e. reduced hours or reduced workloads) or to generate income from other some venture.*** But think about how much less of a burden it would be knowing that you’re not working in your job because you have to.

 

Notes:

* I know the CPF pays an extra percentage point on the first $60,000 of the sum in your CPF but in the larger scheme of things, that’s negligible.

**This, I agree. Unfortunately, it also means quite a bit of lifestyle changes. No more 24-hour prata joints, McDonalds’ and Mustafa, if that’s your sort of thing. Or no more eating cheap and good food like Chicken Rice, Nasi Lemak and Mee Goreng unless you plan to move to Malaysia. But that presents other concerns, like safety.

***It’s ironic how some people who stopped working early actually ended up making more money sharing their experience with early retirement as compared to their previous jobs.

In physics, escape velocity is the minimum speed needed for an object to escape from the gravitational influence of a massive body. – Wikipedia

Some colleagues and I were talking about how really rich people have a happy problem, which is figuring out how to spend all the money they make even while they sit around doing much.

First of all, escape velocity is NOT financial independence.

For me, financial independence is when you don’t need a job to take care of necessary spending. For example, let’s say you need $1,500 a month to pay the bills and the expenditure necessary for survival (i.e. food, clothing, utilities). Financial independence will be when you can generate enough passive income to cover these expenses. The money coming from a job is basically a bonus to treat yourself to things that are more of a luxury (i.e. holidays, gadgets, meals at restaurants).

Escape velocity is a little different. Escape velocity is reached when passive income generated from assets is so huge that you have trouble spending it all even when spending on things that are common luxuries.

Essentially, escape velocity is the complete absence of worry about money.

The idea goes like this:

Once you attain a certain level of wealth, it becomes quite difficult to spend more than the amount you make even if you get very low returns on your investment. For example, someone with $100m in assets that generates just 1% a year has to spend more than $1m a year in order to start running the principal down. Given that the median monthly household income in Singapore was S$8,846 in 2016 (that’s S$106,152 per year), it seems ridiculously impossible to spend more than $1m on consumption goods.*

I call this level of wealth escape velocity because once you reach those levels, it seems almost improbable that a sane person will ever fall back down to the income or wealth levels of an average person.

So what’s escape velocity for me?

I suspect I’ll need a level of about $10m (at today’s prices). At a spending rate of 3%, that’s something like $330,000 a year. Given that my wife and I are not frivolous spenders, that’s probably escape velocity for us.

Notes:

*buying ridiculous things like one-of-a-kind artwork and yachts not included.

Mr Han Fook Kwang, former editor of the Straits Times, wrote in his column today (2 June 2013) about how many Singaporeans are unlikely to retire after 60. The nice spin at the beginning was of course how he felt that 60 was the new 30 and that life at 60 should be more of a starting point rather than an ending point. However, Mr Han painted some disturbing figures thereafter.

One painful truth, though, is that for most who have stopped working, their retirement fund, if that’s what the Central Provident Fund (CPF) can be called, will be totally inadequate to finance the lifestyle they have been used to.

Even those earning fairly high salaries will not have enough savings because of the CPF cap which limits their contributions and is pegged to a monthly salary of $5,000.

That’s not just his opinion- an international study has confirmed it.

The research done jointly by the Australian Centre for Financial Studies and Mercer, a global leader in the retirement business, ranked the retirement income system of 18 countries based on 40 indicators in three areas: adequacy, sustainability and integrity.

Singapore obtained a C grading and ranked 13th. The bottom four places were all occupied by Asian countries – China, South Korea, Japan and India – while the top three were Denmark, the Netherlands and Australia.

But it was in the area of adequacy, which is about whether the retirement fund is enough when it is needed, that Singapore was found most wanting. It ranked second from the bottom, ahead of only India.

The CPF’s own figures support this finding: As at end-2011, more than half of those aged 60 and older had less than $100,000 in their balances, below the minimum sum specified by the CPF Board.

Mr Han’s observation shouldn’t come as a surprise. It’s pretty obvious that the CPF is a terrible scheme as far as retirement plans are concerned, the interest on the CPF OA isn’t even enough to beat inflation; in recent years, the interest rate on the SA can’t beat inflation either. What irks me is that even the former editor of the Straits Times (who obviously is a brilliant person) advocates more intervention rather than learning.

I listened enviously when a Swiss banker here told me that when he retires at 62, he will be paid at least 60 per cent of his last drawn salary for the rest of his life.

That’s a proper retirement scheme which has three pillars consisting of a national, a company and an individual pension plan.

If it were up to me, I would advocate more financial literacy. The state of financial literacy in Singapore is shocking- anecdotal evidence based on “peer speak and observation” suggest that the common approaches to Financial Freedom here in Singapore are:

a) Work hard and accumulate savings

b) Bet big on lottery (see here)

c) Property

d) Retire elsewhere

There’s more to say on each of the above approaches but that’s another post for another time.