2 November 2019

Retirement planning

In simple terms, one can retire when one's annual passive income is more than one's annual expenses. A common rule of thumb for the sum needed to retire is the rule of 25 - based on the assumption of a 4% yield, your net worth should be 25 x annual expenses before you can FIRE.

So let's say you are a lean spender who spend $1000 a month, theoretically you would need 25 x 12000 = $300,000


This theory looks simple but has many underlying assumptions to take note of.


1) Spending remains the same or less

Which means zero inflation and minimal lifestyle changes. At different phase of life, our lifestyle may change, our spending may change to meet our expectations on quality of life. At some point in time when we are old and need hospital care or stay in a Home, the expenses are often not predictable or accounted for.

The younger we choose to retire, the higher the chance of meeting some sort of life contingencies down the road that might involve the expenditure of a big part of our retirement / investment savings. That is why getting good insurance is an important part (though not all) of the equation. Of course some may have the excuse of using family as their insurance.

We also need to take note that money from dividends that we spent cannot be saved up (as warchest) or invested. There would be lost of opportunity costs.


2) Our investment capital for yield is protected throughout our retirement years

Which is not true. Whatever that we chose to invest in has risk - be it equities, ETFs, REITs, bonds... even putting money in the bank has risk. So an ideal scenario is to park our retirement money in somewhere with the least risk for maximum return. To get a 4% return, money has to be parked into a basket of assets with moderate risk, or average out to be so. 

If we adopt the barbell strategy, then we would be parking our money partially in extremely low risk and low yield assets (eg. FD, SSB) and the partially in extremely high risk and high return assets (eg. equities, crowdfund, crypto) that might be risk getting written off anytime. 

Another idea is to partake in high risk investments and yet work really really hard in our youth to generate enough capital to be parked in low risk assets when we retire. So that when we retire, we can draw on preserved capital during a market down-turn or for emergency.



3) Yield stays consistent at 4%

Yield is highly dependent on Mr Market (be it equity market or property market), who is as unpredictable as our emotions when we deal with it. 

Historical data may not be accurately extrapolated unless we draw data sets from different points of the market cycle way back in time to do the calculations. When we use data sets from a deep economical recession period to do extrapolation on the rate of return, suddenly things look very gloomy (invested capital shrinks, yield shrinks). We have no crystal ball to know for sure at which point of the market cycle would we retire in. So people tend to be more optimistic, being in the present market state, and do calculations based on current rate of return when planning for retirement. 


Capital draw down


As mentioned above, our preserved liquid capital is our main buffer during retirement should there be a market downturn. I don't count property as liquid capital. When we write off yield itself and focus on only capital draw-down for retirement, the rate of withdrawal will determine how long our stash lasts. We need to put an arbitrary figure to the life expectancy to calculate what a "safe" withdrawal rate would be. The later we choose to retire, the more stash we will have and the higher is the margin of safety when it comes to capital withdrawal.

Note the word 'preserved'. The equation will not work out if the capital is out there subjected to market risks and fluctuations. It's like trying to plan for weight loss when you only weigh yourself that one time.


Planning till 100 years old

Not everyone lives to a 100 years old. If we plan for a period too long, we may end up stretching ourselves too thin and our quality of life (QOL) goes down. If we don't plan long enough, we will be unsettled by what may come when we run out of money. Do we want to enjoy luxuries for ourselves or leave the money for others to enjoy luxuries? Again, we don't have the crystal ball.

Obviously government does not trust us to plan for our own withdrawal well enough to give us a one lump retirement sum. However, we can somewhat take comfort that as long as Singapore and its government remain stable, and we have contributed substantially to our CPF OA/RA (the preserved capital), we can depend on our CPF LIFE scheme from age 65 onward till we kick the bucket. Read more.

Bear in mind that if we choose to retire early, it would also mean less contribution to the CPF nest.



Is retirement pressing the pause button or to level up in life?

Reaching the golden retirement figure to FIRE is indeed a tempting milestone in life (I still have no idea what's the golden figure to settle for without too many assumptions) and we might say having a goal post is better than none despite a moving one.

The means to an end, however, are just as important. When we are in the accumulation phase of seeking FIRE, we could seek to achieve milestones not just in net-worth (see Investment Moat's stages of wealth) but also in
  • networking / social life (so that we know who we can borrow money from should we run out of it. Ok, just kidding.)
  • knowledge
  • skill sets

When we retire, are we pressing the pause button to stop ourselves from achieving more in the above? 

I don't think it's very fulfilling to retire early and live to a ripe old age of 100, only to realize at deathbed that my life achievements are only at level 10 and not at level 100 that I had envisioned. Therefore, the retirement sum to me may need to encompass the amount needed to do what I want to "level up in life" without having to work 9-5.

Another idea if we are tired of working life, is doing a series of "mini retirements". Pause, go, pause, go. The only catch here is inertia.


My ideal retirement is to sit here all day watching the sea...
[Image credit: Elena Saharova @Unsplash]


Conclusion


In retirement planning, there is no one-shoes-fit-all solution. It is all about finding the optimal balance between - saving up, spending for QOL, undertaking investment risks for returns. 

We often put ourselves in the "ideal" scenario when doing calculations based on the assumption that dividend yield does not fluctuate and neither does our invested capital. Having a sustainable dividend with capital growth is only possible in a secular bull market.

When we actually retire, we can choose to live off our "passive income" and/or "capital draw down". Capital draw down being the riskier option due to the risk of running out of money before we kick the bucket. A safer option is to go into a semi-retirement state when we are still fit to contribute to society by working and so minimizing capital draw down for as long as we feel comfortable.

When planning for passive income, the best is to generate multiple streams (aka own a diversified portfolio). At different phases in life and in the economic cycle, we may need to customize our asset allocation to match.

Despite all the planning done, remember that Life is not a constant and it never will be. So learn to enjoy and make the most out of it whilst planning!



***
Like what you read? View my other posts here

No comments:

Post a Comment

Related Posts Plugin for WordPress, Blogger...