"Big money prefers practicality over opulence."
This is my reply to a recent email from a reader approaching the big 4 in life:
Welcome to my blog. :)
I have to say that I am not a financial advisor. So, I can only share with you what I think makes sense to me.
There are a few issues here:
1. Emergency fund - Generally, people keep 6 to 12 months worth of routine expenses in this fund. Personally, I keep a lot more, about 24 months. So, ask if your emergency fund is excessive. Could the amount actually be lower?
2. 2 room BTO flat - I gather from your email that you are a single. So, I think this is a super choice for a home. Good value for money and most practical. You will be paying for this with your CPF-OA funds, I guess. Of course, you want to set aside some money for furnishing and stuff. Call this your renovation fund or something. For me, I think $10K is probably enough.
3. Endowment policies - These sound like they are going to behave like annuities (for you). Sounds like good retirement income tools although without further details, it is hard to tell if the returns are attractive. If the returns are attractive enough for you and they give you peace of mind, just keep them.
4. Take a look at your CPF-SA. You can do minimum sum top ups yearly up to $7,000 a year. Try to hit the MS ceiling as soon as possible. Let the magic of compounding do the rest. It will ensure that you have a meaningful monthly income from your CPF Life annuity from age 65. It could be as much as $1,300 a month (for now).
5. As for investments, the first rule is that you must only use money you can afford to lose. This means that you should be able to suffer short term losses on paper without having to worry. Money that has been earmarked for specific purposes or might be needed in an emergency should not be used. Then, you have to read up. Pick up some knowledge. If you do not have the inclination to do this, you could consider regular investment plans offered by OCBC or POSB.
Many of the things I have mentioned in this reply are found in my blog. So, just do a search and you will find them. ;)
Best wishes,
AK
All genuine and constructive comments are welcome. No direct or indirect advertisements, please. Thank you.
Related posts:
1. Why emergency fund is important?
2. Affordability and value for money.
3. About life insurance and grapes.
4. $100K to $225K? (CPF-Life)
5. POSB Invest-Saver account.
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31 comments:
Wow! 24 months emergency fund is a lot to me ;-)
For item #5, Phillips Securities has their Regular Investment Plan as well.
Hi Richard,
Well, it does take a bit more time to build a bigger emergency fund. However, I believe that, for most of us, as we grow older, the chances of being retrenched are higher and it also becomes more difficult to get rehired with a similar compensation package. It could take longer to find a job and we could be paid less eventually too.
So, a bigger emergency fund makes sense, especially for more mature workers. :)
If need to keep such a big sum of emergency fund around, prob need to check out ways of risk transfer.
May i know what is the risk that is forseeable and require 24mths of exp?
Hi pf,
Actually, I was partly inspired to have an emergency fund that covers 24 months of expenses after listening to an interview with the Flying Dutchman, the radio DJ. He has one that covers 24 months of expenses.
Certainly, for people who have yet to build up a strong stream of passive income, having a bigger emergency fund does not hurt, I feel.
I know of people who were jobless for 2 whole years or more during the Asian Financial Crisis, for examples.
Then, you might ask why I should need so much in an emergency fund since I have a reasonable passive income stream. It is a pertinent question, of course.
However, the reason is probably somewhat irrational and very personal. It is very much psychological, I have come to realise, and is not something I like to revisit.
Well, I wasn't always financially comfortable. My family came very close to financial ruin. It is hard to really fully recover from something like this. Having more money stashed away is comforting for me. There, I've said it. :)
Any feedback on insurance cover
Actually, I never think 2 bedroom BTO is any good investment for yourself. At 40, you can buy a 4 room flat and rent out 2 rooms. Well, depending on your goals, I think a 4 room flat will definitely give you better cashflow.
Work on your cashflow, what is unnecessary can be eliminated from your cashflow and you can breathe better. We really do not need a lot of things in life.
Hi AK
I agree 24 months of funds is a good estimate. I left my previous job and took a break, end up longer than expected and took 18 months of break.
Now back to the workforce with sufficient rest and a penny wiser through careful investment learned from your blog.
I recently attended a wealth management course. The trainer said his opportunity cost is too much to hv cash lying around. So, his emergency fund comes from a secured credit line of 10 to 15% the value of his fully paid property. The collateral being his property.
If I'm not wrong, he finished paying for his mortgage and gotten this facility w the same bank. No fees or interest if he doesn't utilize.
I thot this is quite a good way to manage.
Btw, if the emergency is for joblessness....the SRS should suffice, isnt it? Lol....
If ur expenses r not high, i think 24 mths doesn't amt to much. Whahaha....
Hi AK, with regards to your point 4. I see that you frequently advocate topping up CPF SA (and SRS for that matter). However I'm unsure if the loss of liquidity for me outweighs the benefit, as I am hoping to retire much earlier than age 65, and need the liquidity to invest into stocks and property when the timing is right. The ideal situation would be if I had enough funds to do both, but I only have enough to do either or. Any thoughts? There's a few weeks left before the end of the year to make the final choice.
Hi battledome,
If you are wondering how much insurance coverage you need, you will have to sit down with your financial adviser and have a discussion. Everyone's circumstances are different.
If you are wondering about why this bit was missing from my reply to the reader, my email was a point for point reply to the reader's email. Insurance was not part of the correspondence.
Hi Apex,
I think it will depend on how much money the reader is prepared to spend on a flat. Also, it depends on how comfortable the reader is in sharing a flat with 2 or more strangers.
A BTO 2 room flat costs $100K or less. A resale HDB 4 room flat can cost 5x more. The cash flow from renting out 2 rooms might net $15,000 a year. It will take a long time to cover the additional cost of $400K.
Of course, it depends on what the reader wants, ultimately. :)
Hi Kwee,
An 18 months break from work is probably enough to rejuvenate anyone. :)
The loss of income could be a small price to pay if the break leads to important discoveries about ourselves and what we want in life. ;)
Having more money put aside is always good because it gives us options, I believe. :)
Hi pf,
No. It is not an option I am comfortable with. In times of need, I do not wish to become indebted. There is just too much personal baggage in this proposal. Sorry if I won't continue the discussion in this vein.
It could benefit other people reading this blog though. Thanks for sharing. :)
As for money in my SRS account, I am not prepared to pay the penalty for early withdrawal. So, that option is a no go for me too. ;p
Hi qook,
I always say we need a level of certainty in life, more so retirement funding. The CPF provides that certainty and a level of risk free returns. No investment in the stock market is able to provide these.
If we should make bad decisions in investments (think Chartered Semiconductor in the past or NOL in more recent times), we know that money in the CPF-SA will continue to compound at 4% to 5% per annum. We know that at age 65, we will have a monthly income from CPF Life which is an annuity and I believe that everyone should have an annuity. :)
Anyway, the max MS top up allowed is $7K per year. We can choose to top up with lesser amounts if we are comfortable doing so. My idea is to max out the MS ASAP and enjoy the magic of compound interest over time. I think my personal experience shows that it works. ;)
The key thing abt topping up cpf SA to reach min sum earlier is the compounding effect that would make SA overflow into OA to service mortgage. No retirement for me if my mortgage is not cleared.
If my cashflow improves later on in life, i wld prefer to pay my mortgage using cash instead of cpf.
First time deciding to save some tax payment after reading your blogs, thus considering $7k into CPF-SA for compounding or into SRS as a war-chest. Should I max out the MS b4 considering SRS if my pure intention is for retirement? But there's a gambler in me who is telling me I may grow more investing with SRS when the time is right to open that SRS war chest.
Hi pf,
Yes, it is the compounding effect that we are after. The compounding effect is going to be more palpable in absolute terms if the base is larger and that is where our effort to top up comes in. It is something that gives me peace of mind as I know a portion of my retirement funding is now safe. :)
Hi Chia,
Well, you will have to find the answer inside you. ;)
Do want to build up the risk free portion of your retirement funding portfolio or do you want to take more risk?
My approach is always to go after the low hanging fruits first. So, anything that is risk free and gives a decent return will be targeted for a start. ;)
Hi pf, I didn't quite understand this point: "The key thing abt topping up cpf SA to reach min sum earlier is the compounding effect that would make SA overflow into OA to service mortgage."
How and when can you make your SA overflow into your OA? I didn't know this was possible.
Thanks AK, issued a chq to CPF Board : D
Hi Chia,
Aiyoh. The person to thank is yourself lah. You have made a decision to lock in a decent risk free rate which will contribute towards your retirement funding adequacy. :)
Qook....hit ur cpf minimum sum b4 55.
Estimates of yearly cpf min sum here
http://madstranger.blogspot.sg/2013/05/cpf-minimum-sum-for-jul-2013-and.html?m=1
Then see how fast u can meet min sum if u do a top up and ur regular contribution. Extrapolate the numbers. ...u will know when u reach min sum and then the excess will go to OA.
AK71 is the one who actually did it. I'm just starting this yr. Gonna take me abt 7 yrs to reach my mim sum. :)
Hi AK,
I figure out that if we need $3k per month to retire. So , at 5%p.a dividend (average out), we need to invest with about $600k. Now, when market is so uncertain,each stock can drop by 10%. Our portfolio value can drop by 60k but our income can be about $30k in a years time. How then can you stay so calm and not be influence by such wild rides? This is especially so if we just started to accumulate and did not benefit from the GFC? Just like to hear from you talking aloud.
Thank you.
JB
Hi JB,
Well, given the scenario you have painted, I would be very worried if the expected income did not happen. If it did happen, then, my expectations as an income investor would have been met. Why should I be worried?
Like I always say, it depends on our motivations as investors. What are we after?
I think it is important to invest but I also think it is important not to overpay. As long as we paid prices which are fair or lesser, we would do well in the longer run.
I was never and still am not 100% invested in the stock market. Big or small, we must always have a war chest ready. This is to take advantage of severe downturns like during the GFC.
Investing for income also ensures that we always have fresh funds coming in which will provide us with more funds to invest in beaten down stocks.
So, although some might have just started to invest and might be suffering from paper losses, believe me when I say that if we continue to invest at lower prices, pacing ourselves and never overpaying, we will do much better over time.
This is the way it works. Well, at least, it has worked for me. :)
Hi pf, thanks for the answer!! Was really helpful. Wow I didn't know this was possible! I thought money in the SA was stuck forever within the SA until cpf life kicked in. Learn something new everyday :)
Pf or AK, could I just ask some more technical questions on how this works? If MS this year is $155k and you already have $155k in SA. Say for example new contributions are 10k to SA in that year. And the next year MS is raised to $160k. Does that mean that the interest of $6.2k (4% * 155k) + 10k contributions minus the net increase of 5k in MS = $11.2k would be transferred to OA, and your SA balance would be $160k exactly?
Hi pf and qook,
I think that there could be some misunderstanding along the way.
Whatever is in the SA stays in the SA even if we have exceeded the MS. At age 55, what is required for the MS is transferred to a newly created RA. The RA will be left to grow for 10 years before CPF Life kicks in at age 65.
There is also a MS for the MA. Now, if we exceed the MS required for the MA, the excess is transferred into the OA.
There are MS requirements for the SA and the MA but only for the MA will we see money in excess of the MS transferred to the OA yearly. :)
Ah ok. Thanks ak for the clarification! I understand now. I have hit my MA minimum sum and knew that the excess was transferred out, but had assumed it was being transferred to my SA. Must examine my cpf statement more closely when YE 2014 statement comes in.
Hi qook,
You are right. The excess is transferred to your SA if you have not hit the MS required for the SA.
As I have already hit the MS required for the SA, the excess in the MA is transferred to my OA. :)
Yar? I thot we hv the same understanding?
Once min sum for SA is reached then excess goes into OA?
I calculated that my MS wld reach for SA if i work and contribute + 7k yearly transfers. Then my excess contribution wld go into OA. The SA's compounded interest will more or less make sure my MS will be maintained until I'm 55.
I didn't mention MA coz my MA min sum is already reached.
Hi pf,
I am not sure I understand your comment but once our SA hits the MS required, we will no longer be allowed to do any top ups.
Anyway, I am happy that you are picking the low hanging fruit by doing minimum sum top ups to your SA. $7K a year (plus compounding a risk free rate of 4 to 5%) means that you will be able to hit that MS required much sooner. :)
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