To get draft 4, click here:
Wednesday, September 16, 2009
Financial Planning - Practical Steps (draft 4)
Some people observed that draft 4 contained a few blank pages. I will be writing them later. I am also adding a few new chapters, to cover tips for middle age and seniors. The book may be increased to 100 pages in later drafts.
Financial Planning (5) - How to invest your savings?
You should invest 80% of your savings for for the long term. Here are the tips for this type of investment:
a) Invest in a large, professionally managed fund as it offers diversification. You will not be badly affected if some investments go bad, as the impact is small and is compensated by other good investments.
b) Choose a low cost fund, where the fund manager takes only a small fee. If you choose an indexed fund, you enjoy diversification and pay a fee of only 0.3% per annum.
c) Invest for the long term, i.e. 10 years or longer. The fund will do badly in some year but will do well in other year. Over the long term, you can get an average rate of return.
d) Choose a fund that invest largely or fully in equity, as equity gives a higher return over the long term. You have already reduced your risk through diversification and averaging out the good and bad years.
You can keep 20% of your savings in a money market fund or in short term assets. The return may be lower, but you can withdraw the savings at any time to meet emergency needs, without having to pay a penalty or suffer a capital loss.
Over the long term, an equity fund should be able to earn you a net return of at least 5%. This is attractive, compared to safe, short term return of less than 1%.
To recap: Invest at least 80% of your savings in a diversified, low cost equity fund that can give a return of at least 5% for the long term. You can reduce the risk through diversification and long term averaging.
a) Invest in a large, professionally managed fund as it offers diversification. You will not be badly affected if some investments go bad, as the impact is small and is compensated by other good investments.
b) Choose a low cost fund, where the fund manager takes only a small fee. If you choose an indexed fund, you enjoy diversification and pay a fee of only 0.3% per annum.
c) Invest for the long term, i.e. 10 years or longer. The fund will do badly in some year but will do well in other year. Over the long term, you can get an average rate of return.
d) Choose a fund that invest largely or fully in equity, as equity gives a higher return over the long term. You have already reduced your risk through diversification and averaging out the good and bad years.
You can keep 20% of your savings in a money market fund or in short term assets. The return may be lower, but you can withdraw the savings at any time to meet emergency needs, without having to pay a penalty or suffer a capital loss.
Over the long term, an equity fund should be able to earn you a net return of at least 5%. This is attractive, compared to safe, short term return of less than 1%.
To recap: Invest at least 80% of your savings in a diversified, low cost equity fund that can give a return of at least 5% for the long term. You can reduce the risk through diversification and long term averaging.
Tan Kin Lian
Protect against critical illness - buy term and invest the difference
I wish to give consumers another choice of how to protect against a critical illness: buy a 25 year term insurance (that also covers critical illness) and put your savings in a low cost fund.
Here is a hypothetical example (to illustrate the concept). You can use the actual figures relevant to your age.
Suppose you have to pay $3,000 a year ($250 a month) to get a critical illness policy covering $100,000. If you decide to take the risk on your own and to invest the annual savings of $3,000 to earn just 3% per annum. The savings will accumulate to $113,000 at the end of 25 years. The accumulate savings will be more than the amount payable under the critical illness policy!
You can buy term insurance (including cover for critical illness) for 25 years for a small premium. Actually, you only need a decreasing cover, as the reduction in each year is compensated by your annual savings. The cost of this cover can be quite low, probably around 5% of the premium. See this FAQ for indicative rates. (You have to take one-third of the rates for $100,000 cover and increase it by 50% to 100% to include critical illness.)
The premium that you put in a critical illness policy will also have a cash value. You have to find out the cash value at the end of 25 years and compare it with the amount that you can get by investing on your own. If the difference is small, it is all right to buy the critical illness policy. If the cash value is significantly lower, than it is better to avoid the critical illness policy.
Here is a hypothetical example (to illustrate the concept). You can use the actual figures relevant to your age.
Suppose you have to pay $3,000 a year ($250 a month) to get a critical illness policy covering $100,000. If you decide to take the risk on your own and to invest the annual savings of $3,000 to earn just 3% per annum. The savings will accumulate to $113,000 at the end of 25 years. The accumulate savings will be more than the amount payable under the critical illness policy!
You can buy term insurance (including cover for critical illness) for 25 years for a small premium. Actually, you only need a decreasing cover, as the reduction in each year is compensated by your annual savings. The cost of this cover can be quite low, probably around 5% of the premium. See this FAQ for indicative rates. (You have to take one-third of the rates for $100,000 cover and increase it by 50% to 100% to include critical illness.)
The premium that you put in a critical illness policy will also have a cash value. You have to find out the cash value at the end of 25 years and compare it with the amount that you can get by investing on your own. If the difference is small, it is all right to buy the critical illness policy. If the cash value is significantly lower, than it is better to avoid the critical illness policy.
If you are younger, you may pay a lower premium for the critical illness policy, but if you extend the calculation to a longer period (say 35 years), you will get the same conclusion, i.e. that you will be able to accumulate sufficient savings to get the full sum assured.
I have given hypothetical figures to illustrate the approach can consumers can take to make the right choice. You may need to find an adviser who is willing to give you the advice for a time-based fee, so that you get impartial advice.
To recap: Consider the approach of "buy term and invest the difference". Get the figures relevant to your actual situation. Find an adviser who is willing to give you impartial advice for a fee.
Tan Kin Lian
Tan Kin Lian
Appeal to MAS - regulate investment products
So far, all the measures that MAS has focused on are 1) training of sales staff, 2) labelling of products, 3) sales process, proper documentation etc.
However, the MAS has failed to address the root cause of all the mis-selling in the financial industry. They have failed to address the conflict of interest between the way the sales force is remunerated and the interests of clients.
Clients want good investment performance, within their proper risk profile. They want a diversified portfolio.
The sales force and the banks that set the score cards want to sell products with the highest sales revenues. The higher the sales revenue, often the poorer the investment performance for clients.
By allowing banks to sell products with upfront sales charges, the sales force have no incentive to conduct due diligence of the products. In fact, the sales force is incentivised to go for the products with the highest sales margins, often embedded in flow products, structured products and treasury products. These products often provide very limited upside but unlimited downside.
Flow products like equity linked notes and dual currency investments involve the clients selling put options for a fee. Often the spreads taken by the banks are 80%, while the client earns only 20%. Yet the spreads are not transparent. The client only knows what he has been quoted. Worse, the little fees that client earns from selling these options involve unlimited downside if the underlying equity or the currency being paired drops in value.
Sales people love such flow products because 1) they earn very high margins at expense of clients, 2) these investments are short-termed, often 1 month for an ELN and 2 weeks for a DCI, and they keep rolling the clients every time a contract expires until they customer gets converted. if the stock rises or the currency such as teh AUD rises, customer merely gets a small yield like 1% per month. But if the stock or currency falls, customer receives the underlying stock and currency. Hence, the return is asymmetric.
When the investment climate is favourable for equities, often the sales force would steer clients doing such flow products, which earn very little yields, when the clients are better off investing in mutual funds, ETFs, products that constitute a core portfolio.
There are also no controls on the spreads that a bank can take for bonds, convertible bonds, preference shares. They are quoted as bid ask with the spreads embedded. However, bonds, convertible bonds and preference shares provide much better returns to risk ratios than flow products and hence such spreads are often quite justified.
The banks cannot be relied on to treat customers fairly because they are under tremendous shareholder pressure to produce ever increasing revenues. Any one from senior management in a consumer bank will admit that their sales target rises 20 - 30% per annum, regardless of market climate. Hence, banks tend to veer towards selling products that generate the highest revenue at the expense of clients.
There are also no controls on the spreads that a bank can take for bonds, convertible bonds, preference shares. They are quoted as bid ask with the spreads embedded. However, bonds, convertible bonds and preference shares provide much better returns to risk ratios than flow products and hence such spreads are often quite justified.
The banks cannot be relied on to treat customers fairly because they are under tremendous shareholder pressure to produce ever increasing revenues. Any one from senior management in a consumer bank will admit that their sales target rises 20 - 30% per annum, regardless of market climate. Hence, banks tend to veer towards selling products that generate the highest revenue at the expense of clients.
The only way is for MAS to legislate or control the spreads earned from flow products, unit trusts and all investment products. The banks will likely find other ways to make up for the lost revenue by implementing performance fees or wrap fees, which will align the interests of teh bank with the customers.
The MAS must take this financial crisis as an opportunity to take bold steps towards reforming the way investment products are sold by banks. Otherwise, I suspect more social harm will fall on the public. If the government is willing to take steps to control the rise in property prices recently, why not take equally bold steps to reform the financial industry?
Greg Wang
The MAS must take this financial crisis as an opportunity to take bold steps towards reforming the way investment products are sold by banks. Otherwise, I suspect more social harm will fall on the public. If the government is willing to take steps to control the rise in property prices recently, why not take equally bold steps to reform the financial industry?
Greg Wang
A suggestion to treat citizens better
Dear Mr. Tan,
The PM talked about treating Singapore citizen better, as compared to PR. I will recommend them to do this:
a) portion out our assets from Temasek holdings and GIC (not all of GIC as some are our own CPF money)
b) do a proper mark-to-market
c) unitize it (and call it Singapore Thank You Fund)
Each singapore citizen will be given shares based on the following:
a) number of years as citizen
b) number of kids he/she produced
c) done NS and reservists
So, the older citizens who has provided the nation with kids will be getting a larger number of shares as compared to a newly converted citizen who is single.
Add up all the shares and match them to the units of the Singapore Thank You Fund. Citizens will be given the units of the Fund in their CDP account. They can sell the units only back to the government. The government will provide transparent reporting of the values of the underlying assets so that the unit price can be calculated. Based on certain predetermined criteria, citizens can sell the units at a discount (depending on the age of the citizen)
Criteria will be something like this:
a. prolong joblessness
b. prolong sickness with no money to pay for
c. calamity in the family (sudden loss of a spouse)
I hope the old citizens (especially the poorer ones) will be able to benefit from Singapore's growth in the past 50 years, before they die.
Heng Chee Meng
The PM talked about treating Singapore citizen better, as compared to PR. I will recommend them to do this:
a) portion out our assets from Temasek holdings and GIC (not all of GIC as some are our own CPF money)
b) do a proper mark-to-market
c) unitize it (and call it Singapore Thank You Fund)
Each singapore citizen will be given shares based on the following:
a) number of years as citizen
b) number of kids he/she produced
c) done NS and reservists
So, the older citizens who has provided the nation with kids will be getting a larger number of shares as compared to a newly converted citizen who is single.
Add up all the shares and match them to the units of the Singapore Thank You Fund. Citizens will be given the units of the Fund in their CDP account. They can sell the units only back to the government. The government will provide transparent reporting of the values of the underlying assets so that the unit price can be calculated. Based on certain predetermined criteria, citizens can sell the units at a discount (depending on the age of the citizen)
Criteria will be something like this:
a. prolong joblessness
b. prolong sickness with no money to pay for
c. calamity in the family (sudden loss of a spouse)
I hope the old citizens (especially the poorer ones) will be able to benefit from Singapore's growth in the past 50 years, before they die.
Heng Chee Meng
US Health Care Industry
What's wrong with the industry, as told by a whistle blower. Read this report.
Singapore system getting rotten?
Dear Mr. Tan,
I hope that our top leaders realise that the Singapore system is getting rotten:
a) So much cheating going on
b) People in charge are not taking action - just passing the buck around
c) No sense of duty or pride
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