TL;DR: If we start saving a greater percentage of our monthly income early, and invest the savings prudently without incurring the expensive management fees, we would be able to accumulate a substantial retirement nest-egg (estimated $1.5 million pot in 35 years with $2k put aside each month)
I have been chancing upon various “savings plan” and “retirement planning” sales pitches recently, and thought that I should pen down and share my thoughts on retirement planning for my friends.
We are faced with various “headwinds” today that would have an impact on our retirement planning given the current low interest rate environment and volatile capital markets across all asset classes.
I have been practising some form of financial planning over the past 10 years. I have made some mistakes and am continuing to learn on how to improve my financial planning and passive investment approach. However, I will like to share some of the key lessons that I have learnt to-date.
1. Start Saving Early.
The rule of compounding is simple. Assuming Mr X starts saving & investing $1,000 a month at 25 years old, he would have built up a retirement fund of approximately $743,000 by 60 years old, assuming an annual return of 3%. However, if Mr X starts saving $1,000 a month starting from 35 years old, he would have built up approximately $447,000 by 60 years old. In order to amass the equivalent amount of $743,000, he would need to save $1,667 a month.
2. Save More (as a % of Income).
Simple as it sounds, but assuming the same Mr X earns $3,300 a month. If he can save approximately 60% of his monthly income (i.e. $2,000) instead of original 30% ($1,000), Mr X would have built up a retirement fund of approximately $1.48 million by 60 years old if he started saving at the age of 25 or approximately $892,000 if he started saving at the age of 35, assuming an annual return of 3%.
It may be challenging to save such a high percentage if Mr X has dependents, a home mortgage to finance, and/other financial commitments. I faced the same dilemma too, and sometimes feel that it would also be a function of lifestyle and the short-term sacrifices (such as forsaking a car or to purchase a cheaper car) to achieve the longer-term target of achieving financial independence at an earlier age.
3. Invest a % of Savings.
The examples above assumes an annual rate of return of 3%. In today’s low interest environment where bank deposit rates are paying approximately 0.1-0.2%, it is important that we consider staying invested in the markets to have the chance of achieving the implied 3% annual compounded returns. For example, a $120 investment in S&P500 Index ETF (SPY:US) in 10 years ago in 2005 would be worth $200 today in 2015, representing approximately 80% total return or an annualized compounded return of 5.2% per annum.
4. Invest for the Long-Term.
Following the S&P500 example above, it is important to invest for the long-term since we would have made a loss on our investment if we have exited in year 4-5 (2009-2010) instead of year 10. Therefore there would be fine-tuning of the retirement fund investments as we approaches our retirement to lock-in profits in across a 5-year horizon instead of a fixated exit on a specific retirement year which may be the worst time to exit an investment. The comforting fact is that the stock markets broadly reflect and track economic growth of the country (since they are represented by a large number of listed companies that provides goods and services for the economy) and the S&P500 had illustrated a compounded 9% annual return over the 30-year period over 1985-2015. Therefore if we can invest for the long-term and monetize / take partial profit in the across a 5-year horizon from our target retirement age, we should be able to achieve the blended returns of more than 3% per annum.
5. Invest Cheap, Slow and Steady.
I am a big supporter of the passive investments via ETFs with low cost expense ratio (which is the annual fees & expenses charged by the fund manager). I like a number of the liquid ETFs that have expense ratio of less than 0.30%, which compared to the active fund management / unit trusts’ annual fees of approximately 2% (and the usual 2/20 charged by hedge funds), you get an implicit savings (or an approximate +1.7% extra compounded annual return) for your investment. There are certainly excellent fund managers who can achieve “alpha” and beat the benchmark indices, and it may be useful to allocate some investments to these out performers. However, similar to doing individual stock picking, it is challenging to pick fund houses who may be able to generate the desired long-term returns (specific fund managers may quit the fund, certain hedge fund trades may get too crowded and the fund’s supposed “alpha” strategy ended up tracking the “beta” of the stock market etc). Therefore, rather than chasing the potential huge gains that may proved to be speculative, a slow and steady approach would to invest a portion of the savings in in the low-cost ETFs would help to achieve the long-term investment objectives whilst keeping the investment costs low.
Welcome your thoughts on retirement planning.