We spend one fifth of our lives in retirement. Singaporeans, who retire at 60, can look forward on the average to another 15 years of living. These can be the most carefree years of your lives. By then, your housing loan would be fully paid up, and your children would probably have their own families. Now is the time to take it easy and do the things you have always wanted to do but never found the time. However, to spend 15 years without a full-time job does require a considerable amount of financial resources. Without adequate financial resources, 15 years can seem an eternity. The golden rule for retirement planning is to start planning as early as possible.
People make three common mistakes in retirement planning.
One, they put off retirement planning until it is too late. It is human nature to pay less attention to long-term goals while focusing on more immediate needs or wants such as starting a family, saving for a house, buying a car, upgrading to a bigger property and so on. Or, you may be too caught up in the rigours of career-building to notice how quickly time slips by. Whatever the reason, early planning is essential if you want to enjoy a comfortable retirement. The later you start building your nest egg, the less time you give your money to work for you and the less financial resources you will have for old age.
The second common mistake in retirement planning is saving too little. As a nation, Singapore boasts one of the highest savings rates in the world. But this is mainly because of the compulsory Central Provident Fund (CPF) Scheme. Just how much do Singaporeans save apart from CPF? The answer is not very much.
Statistics show that the average Singapore household saved 11% of gross income in the 1980s. This saving rate has dropped to only 5% in recent years. What could account for this drop? Do we harbour the notion that our CPF savings will be enough to tide us through retirement? The fact is: a large portion of Singaporeans' CPF savings is used up for housing. This means that unless we are prepared to downgrade to smaller properties for retirement, we may well end up being asset-rich but cash-poor.
Could the decline in savings rate be the result of poor budgeting? If so, it is time we start to practise family budgeting. Budgeting is useful because it helps you keep your expenses in check, live within your means and save. It is a sensible habit not just for retirement, but also throughout life. What could be more satisfying than being able to enjoy every cent you spend, knowing that you have already provided for yourself and your loved ones?
The third common mistake people make in retirement planning is investing either too conservatively or agressively. Some people equate prudent investing with putting all their money in the bank. This is a mistake because interest on bank deposits seldom keeps pace with inflation. Over time, inflation erodes a large portion of the money kept in your bank account. The moral of the story is: when deciding what to invest in, you should take into account your age, risk appetite, investment horizon among other factors. The younger you are, and the more secure is your job, the less conservative you should be in your investment policy. For example, a young and financially secure person who leaves all his money in the bank is missing out on the kind of potentially high returns he needs to earn in order to enjoy a good retirement. Assets that provide higher returns on average than bank deposits include stocks and real estate. As these are real assets, they give you a much better chance of beating inflation than nominal assets like deposits or bonds.
It is also possible for one to make the mistake of being overly aggressive at the wrong time. For example, a person who is in his 50s should take much less risk than a person in his 30s. The closer you are to retirement, the more conservative your investment policy should be. Your priority then would be to preserve the wealth that you have accumulated in your younger years. To invest the bulk of your portfolio in risk assets such as stocks at this time is to court financial disaster because stock prices can be extremely volatile. The uncertainty of stock prices means that you may not find it profitable to liquidate your holdings just when you need the money to pay for essentials like medical bills, or to supplement your CPF annuity income.
Now that you know the pitfalls in retirement planning, let us consider the steps in starting a retirement plan. Retirement planning can be carried out in four simple steps.
Step1: Set Your Goal
The first step in retirement planning is to decide what lifestyle you wish to enjoy in your retirement. In order to arrive at concrete plans, you need to put a number to your retirement goals. There are two ways to do that. One method is to project what your last-drawn salary will be just before retirement and then assume you need a certain percentage of that salary to support your retirement lifestyle. Based on actuarial estimates, a typical range is about 70 - 75%. Another method is to draw up a detailed list of your current expenses, add or delete expenses to reflect
anticipated needs during retirement, and then project the resulting expenses forward using an assumed rate of inflation. Imagine for a moment, the amount of funds you will need to support 15 years of retirement. If you think the amount is a huge one, you are on the right track. Consider a 'typical' young couple whom we shall call the
Tans. The Tans are currently 30 and are each drawing a salary of $2,500 a month. They figure that if they retire at 60, they will need 75% of their last-drawn salary during their first year in retirement. After that, the amount should grow at the rate of inflation (assume this is a modest 3% per annum) for the next 15 years. By the time they retire at 60, the Tans will need a combined retirement fund of about $2.2 million. Clearly, this is no small beer. Building such a large retirement fund will require years of planning.
Step 2: Estimate Your Financial Resources
Most people will have some financial resources of their own for old age. This can be in the form of CPF savings, property, endowment policies, savings in the bank or investments in stocks or unit trusts. Thus, you need to estimate how much financial resources you are likely to have by the time you retire. This can be a difficult task, especially for risky assets like stocks since share prices are volatile. However, a reasonable guide for the future is to look at the historical returns for stocks or for that matter, any asset class.
Step 3: Estimate Shortfalls
The next step is to determine whether your resources are adequate to meet your needs. If not, you face a gap that must be closed. One of the benefits of thinking early about retirement planning is that if you spot a large shortfall, you have sufficient time to take concrete actions to close the gap.
Step 4: Formulate a Savings/Investment Plan
There are many ways you can close a shortfall. First, you can learn to budget your expenses and save more. Second, you can invest your money to earn returns that are higher than bank deposit rates or inflation. Third, you can opt for a more modest lifestyle in retirement. The last option can be avoided if we are careful with our money, and invest prudently throughout our lives.
When formulating your investment plan, take into account the following factors: your risk-tolerance, financial position, age and need for liquidity. If you are young, financially secure and do not need to use your funds for the short term, you should invest between 60 - 70% of your wealth in assets that have higher risks but also higher potential returns. These include assets like stocks, equity mutual funds or perhaps a second property.
You should review your investment plan every now and then, and make the necessary adjustments to your portfolio as you age or as your family circumstances change. By the time you reach your early 50s, you would have accumulated a tidy sum for retirement. At this point, it is prudent to switch to a more conservative investment policy aimed at preserving your hard-earned wealth. An appropriate portfolio at this stage might consist of 10% in stocks, 60% in bonds and 30% in bank deposits.
In conclusion, how well you live during your retirement depends on how you save and invest while you were working. Remember that it is never too early to start planning ahead. With time on your side and a systematic
retirement plan, a carefree and comfortable retirement can be within reach.
