Wednesday, December 23, 2015

Your Money Ratio$

Recently I have been reading this book which I thought is really good for financial planning:

They provide you with advise such as how much you should be saving at every age, how much you should invest, the maximum debt you should get yourself into etc.

Let's get into the details. Assuming you want to retire at age 65, and require 80% of your last drawn income for retirement. How much savings should you have at each age group? The book introduces the capital to income ratio, the savings ratio and the mortgage to income ratio to address this: 

Age Capital to income ratio Savings ratio Mortgage to income ratio Stocks Bonds
25 0.1 12% 2.0 50% 50%
30 0.6 12% 2.0 50% 50%
35 1.4 12% 1.9 50% 50%
40 2.4 12% 1.8 50% 50%
45 3.7 15% 1.7 50% 50%
50 5.2 15% 1.5 50% 50%
55 7.1 15% 1.2 50% 50%
60 9.4 15% 0.7 40% 60%
65 12.0 15% 0.0 40% 60%

For example, at age 35, you and your wife if married should have savings (bank deposits, insurance, stocks, bonds, CPF) that is 1.4 times your total combined annual salary. You should also be savings at least 12% of your total combined annual salary. Your existing mortgage debt should not be more than 1.9 times of your total combined annual salary. Further, you should invest your savings in a 50%-50% stocks to bonds ratio.

The 5% Rule

The way this works is that at age 65, you have 12 times of your last drawn pay as savings. Assuming you earn 100,000 at age 65, you will have 1.2 million in savings. You will withdraw 5% of this savings every year for your expenses. So 5% * 1,200,000 = 60,000. However, earlier we said that we need 80% of our last drawn income for retirement, which means we need 80,000 a year. So where does the additional 20,000 come from? The author suggests that this should come from social security schemes, which in the Singapore case, is CPF life annuity.

Withdrawing 5% of your savings is only a base, and has to be adjusted for inflation. So say for example at age 65, you withdraw 5% of your savings. At age 66, inflation is at 3%, which means now you have to withdraw 8% of your savings to buy the same amount of goods.

To ensure your money doesn't run out prematurely, it is important to keep your savings reinvested. The author assumes you can earn 4.5% real returns yearly on your savings fund, over a 40-year cycle. It is important to note this 4.5% figure is after accounting for inflation. If inflation is 3%, and the financial markets return 7.5%, after accounting for inflation the real return is 4.5%.

I am happy to say that our household met all these ratios, except the 50%-50% stocks to bonds ratio. Currently we are heavier on stocks.

It is important to note that the above is written for an american in mind, how do these ratios change when we consider the Singapore context? This is another piece of research to be worked on.

Sunday, December 20, 2015

Financial Snapshot

I decided to do a snapshot of finances at my current state, and perhaps do it once a year, at the end of every year.

This is so that if I ever retire say in 1X years, I have a record of my finances at every year which I can share with people on 'how I retired at age 4X in 1X years'.

Naturally, I do not want to disclose too much details or my net worth, amount I have in banks etc. so I will just share the following:

Year ending Stocks Bonds Cash for investment
2015 52451.71 20872 8335.63

Not included in the above are bank savings, insurance policies, CPF, SRS etc. The above are just the amount of stocks and cash in my 2 stock brokerage accounts, the stocks in my BCIP and SRS account, and the bonds I am holding at the moment.

So that's what I have now, next year in Dec I will update this table and see how much the portfolio gained/lost.

Tuesday, December 15, 2015

How to choose an Endowment Plan

In this post I want to share how I  am choosing an education endowment plan for my child.

Disclaimer: I am not a finance professional, all views expressed here are my own and should not be taken as investment advice. You should do your own due diligence when investing.

Quotations provided by insurance companies are lengthy, complicated, and most people don't bother with the details. They simply buy perhaps based on recommendations of friends, or worse yet simply because the insurance advisor say it is a good deal. But if you think about it, why should the insurance advisor say anything else? After all, she only makes money if she sells you the product. If her plan sucks, she won't say it for sure.

When I am choosing an education plan for my child, I tried searching online for advice on how to compare insurance quotations, but I could not find anything useful.

Sure, there were some articles providing advice but they were really basic. Such as, choose an insurance policy with the right time frame, that suits your needs etc.

In my opinion, there are several important things in an insurance quotation you should pay more attention to:

  • Total premium paid
  • Breakeven year - the first year in which surrender value (at say 4.75% projected returns) > total premiums paid
  • Guaranteed surrender value
  • Death benefit

These ratios are important in comparing quotations from different insurance agents (in all these ratios, the higher the better):

  • Year at which policy matures / Breakeven year
  • Total premium paid / Total distribution cost
  • Death benefit at end of policy term / Total premium paid
  • Guaranteed surrender value at end of policy term / Total premium paid
  • Actual % returns per year (based on say a 4.75% projected investment return)

I get at least three quotes from different insurance companies, and I compute all these ratios in a spreadsheet and compare them side-by-side. For those quotations that score the highest in each category, I assign 1 point. At the end, I choose the quotation with the highest points.

What do you think of this method? I believe it is much more quantitative and objective than simply choosing a plan based on how well you relate to the insurance agent!