The Ideal Retirement Plan: "Marry an old rich broad and wait for her to die."      - Ivan Wilson

After I published the first part of this article regarding the concern of his financial at retirement here.

http://klse.i3investor.com/blogs/kcchongnz/82882.jsp

Someone posted an interesting comment below which also reflected my thought on it.

[Posted by chyokh > Sep 14, 2015 04:21 PM | Report Abuse

4.4 mil in assets at age 64 and still worrying. I have much less than you but I am already travelling round the world enjoying my retirement.]

A recent survey by global insurance group AIA revealed that the average amount middle-class Malaysians desire to have in their savings for when they retire comes to RM1.9 million. However, according to recent figures from the Employees Provident Fund (EPF), the approximately 70,000 active 54-year-old contributors have an average savings of just 167000 in 2013, below the recommended minimum savings level of RM196800. The situation is made more alarming by the revelation that 69 per cent of all EPF contributors of the same age have less than RM50000 in their accounts.

As the average Malaysian is expected to live until 75, retiring at 60 with RM167000 would mean surviving on just RM700 a month for the rest of their days or below the government’s poverty threshold figure of RM830 per month in peninsular Malaysia.

As long as one has a reasonable retirement saving, he needs not necessary to have millions of assets in order to lead a happy retirement life. The only caveat is he doesn’t ever get greedy and think of making millions speculating in the stock market with the use of other people’s money. Only through gambling, using margin finance in stock speculation included, can wipe out whatever one has and derails his retirement planning. It is good that nowadays there are no more vigorous promotion of this use of margin finance in i3investor now.

Most retirees are just hard working individuals working as an employee and few are involved in business. They do not have RM4.4m of assets acquired at retirement, with no debts, even for most professionals. Most of them work hard to put food on the table, buying a house, to bring up children and support their education up to tertiary level, many even send their children for the costly overseas education, and even help them out when they first starting work like first payment for their house and car. That is the culture of ours but not that of the western people. What is left for these retirees could be just a meagre sum barely enough for a no-frill retirement life.

Table 1 in the appendix shows a more realistic picture of the asset of a typical middle income retiree, John who has just retired at the age of 65.

Personal balance sheet of a middle income retiree

Table 1 in the appendix is the balance sheet of John, with a total asset of RM2.0m, and zero debt. It is always an excellent idea to get rid of all personal debts at retirement. The liquid assets, including EPF saving, is RM1m, and a house worth about RM1.0m. Figure 1 below shows the total asset distribution.

The pertinent question is, can this amount of retirement sum provide an inflation adjusted RM6000 a month expenses to last until 25 years later when the retiree, John, is at the age of 90? And if not, what lifestyle adjustment he has to make?

Financial planning at retirement

“I have got all the money I’ll ever need if I die by four o’clock.”    Henry Youngman

Let us look at the cash flows which can be produced from the liquid assets of RM1.0m with asset allocation as shown in Figure 2 below.

Table 2 below shows the weighting of the liquid assets of John. The expected long-term return for each asset, which are all in fixed income, is also tabulated as shown.

Table 2: Assets and expected return

It is assumed that the EPF money is left at where it is as EPF provides a reasonable high after-tax and almost risk free return of 5.5% and John is drawing an annuity, a constant stream of cash flows from it for 25 years. The long-term return of fixed deposit is assumed to be 4% a year, and cash at 2%. With the present asset allocation, the weighted average return of the portfolio is at 4.6% as shown, barely beating the rate of inflation by a few tenths of a percentage. How long can this money last?

Figure 2 below shows the retirement sum can only sustain John for 13 years when he reaches the age 77. This clearly is inadequate as he wishes to have money to last until age 90, just before he dies.

John thinks of increasing his return from his assets. Since he already has a total of RM600000 in fixed income in EPF and cash, it may be better to withdraw all his fixed deposits of RM400000 upon maturity and re-allocate them into stocks to earn higher expected return to meet his financial goals as shown in Table 3 below.

Table 3: Asset re-allocation

The new asset allocation is okay as still 60% of the assets are in fixed income befitting his age profile. It is hopeful that with stocks, the return can be much higher such that the money John has with the higher return can last until he reaches the age of 90.

However, as shown in Table 3 above, the return of stocks has to be at a minimum of 18% a year in order to achieve a portfolio of return of 10.2% meeting his goal of RM6000 a month in today’s money such that the money is not depleted until age 90, 25 years later as shown in Figure 3 below.

The high expected CAGR of 18% for stocks, is possibly achievable as shown by the return of many super investors in the US using the value investing strategies in the link below.

http://klse.i3investor.com/blogs/kcchongnz/50988.jsp

However, this kind of achievement, besides requires a lot of skill, more information about the companies, more risks are entailed and plenty of luck must come in too. Hence, it is not dependable in a retirement planning, nor in any form of personal financial planning. In retirement planning, I would like to stick to a conservative long-term CAGR of 10%, or 12% the most.

With the stock expected return of 10%, the weighted average return of the portfolio is 7.0%. It can be shown that the liquid assets can only last until the age of 80, just another three years more. This still falls short by 10 years. This shows that John will have to fall back on his fixed asset, his mortgage-free house to fulfil his retirement financial needs.

In overseas, both a reverse mortgage and a home equity loan are commonly used options by home owners to tap into the equity in their home, to free up some equity. Here, John also can down size his house, i.e. he can sell off his present house which is too big and expensive now for both of them, and buy a smaller apartment unit, say for RM500000. He can also sell it and opt for renting when he has no more money left. The latter option is assumed here with an additional expense in rental rate of RM1500 a month at today’s money.

Figure 4 below shows with the above lifestyle adjustment, his fund is able to him till the age of 90 with the sale of his house 15 years down the road and opt for renting, or go to a rest home for the remaining 10 years.

A better option?

John and his wife like food, good but cheap food. They often travel to Ipoh to eat nice chicken rice, curry laksa, fish head curry and also nearby seaside town of Tanjung Tualang to get fabulous seafood. Ipoh also has a couple of nice golf courses which John likes; the Royal Perak and Meru Resort Golf Course. Houses are much cheaper than those in Petaling Jaya, where they are staying now. A nice single story house in a good area costs less than RM500000. They are seriously contemplating to sell off their house in Petaling Jaya and move to Ipoh for retirement. They can unlock a tidy additional sum of RM500000 for retirement. Besides other cost of living area also much lower than that in Petaling Jaya. Table 3 below shows his new asset allocation after doing that.

Table 3: Asset allocation by downsizing

With RM1.5m in liquid asset with an asset allocation again at 60%:40% in fixed income: equity, an assumption of 10% return for stocks, and hence a weighted average portfolio return of 6.4%, there appears to have no problem for John and his wife to live through their retirement with an inflation adjusted amount of RM6000 a month until age 90 as shown in Figure 5 below.

Even if the return of stocks falls short say to 8%, John would still have his house left as a cushion.

This moving to a small town may be a better option for many retirees. However, they have to take into consideration that their children, and grandchildren are mostly working and living in the Klang Valley. Their friends and relatives are also mostly there now and they have to start afresh to build up a circle of friends. It could be a big move and more thinking and fact finding are required before acting.

Retirement Annual Cash Flows

The above represents a simple retirement planning as there is limited information. However, retirement planning is fraught with important assumptions about many significant, unpredictable events, which can substantially impact cash flow calculations and results. There are simply too many scenarios and variables, both internal such as lifestyle choices, risk appetite and changes when get older; as well as external factors such as inflation, health care costs, variation of interest rate and market return, longevity, unexpected life events etc. That is why I like to do the retirement planning in an annual cash flows basis such that these variables can be adjusted easily at different stages as shown in the link below:

http://klse.i3investor.com/blogs/kcchongnz/49384.jsp

Conclusion

Not all retirees are so lucky to have abundant retirement saving and have no worry about retirement financially. Some still need to think about how to properly allocate their resources to make their retirement saving to work harder and earn a little higher return, without undue high risks, in order to last before they expire. Some may have to think about downsizing their houses, and leave for smaller towns to lead a new life.

We also have to bear in mind that to obtain a reasonable nominal return of 8%-10% a year for stocks for long period of 25 years, John is still required to have the knowledge and ability in investing with a sound, safe and prudent manner.

For those young people, it is best to start to build up long-term wealth from young to gain from the magic of compounding, the eighth wonder of the world.

http://klse.i3investor.com/blogs/kcchongnz/77460.jsp

For those retirees, as well as those young person who wish to build up long-term wealth and handle their personal finance better, who are keen to learn the art of value investing, wealth accumulation and preservation, or even unsure of their finance during retirement, please contact me at

ckc14training@gmail.com

K C Chong (CFP)

Appendix

Table 1: Net Worth