The long-term goal of financial independence must take precedence over excessive home purchase and car ownership in Singapore.
EARLY MOVER ADVANTAGE Delaying saving for retirement is a high risk strategy as the required return on investment over a shorter time horizon will be considerably higher than if one started investing early in life.
THERE are serious concerns raised recently regarding the high levels of household debt in many countries, especially in Singapore and Malaysia. In the midst of focusing on the debt management side of things, our society seems to have relegated the priority of retirement planning as an afterthought. Our government has taken the lead to set limits on how much financial institutions can lend for consumer loans for homes and cars. The Total Debt Servicing Ratio (TDSR) of 60 per cent of monthly income is part of a framework for prudent lending for the banks. The initiative to judge the optimal level of debt repayment should actually fall on the individual and not the banks or the government. As a practical guide, the decision to acquire a private home and a car (for those who can afford one) should be made based on tackling the retirement funding as a priority before borrowing to the hilt for the house and the car.
For the purpose of calibrating the ideal combination of retirement savings and loan repayments for home and car, let's assume a couple, Jack and Diane, who are both 40 years old with a current combined monthly household income of $10,000.
Replacement income
The first step to quantify how much is required for their retirement capital is assessing the projected retirement lifestyle in current dollars. For a couple earning $10,000 a month today, a replacement income of 50 per cent, or $5,000 per month, in today's purchasing power may be an initial target. (A lower income couple will require a higher amount of replacement income for their basic needs in retirement). It doesn't take much for Jack and Diane to spend $5,000 on food, transport, healthcare, live-in or part-time helper, personal items and pleasure. There will be no mortgage to service or children to support in retirement. The ability to own a car in retirement is questionable for this quality of lifestyle.
Savings capacity
Our work with individual clients, mainly professionals, over the years conclude that a savings ratio of 20-25 per cent of annual income is required for an accumulation phase and consumption phase of 30 years each. In other words, start active saving from age 30, commence drawdown at age 60 and expect to live till age 90. Most middle-income families do not have the discipline or the capacity to save more than 10 per cent of their income as they juggle debt servicing and supporting children and ageing parents. This is where the relevance of the newly legislated TDSR comes into play. If Jack and Diane borrow up to the regulatory limit, how much will they have available to save and invest for post-employment living expenses? Let us assume that this couple has 20 more years to accumulate their retirement capital.
How much debt can you take on?
If Jack and Diane are able to save $5,000 per month after paying for current living expenses and they set aside $2,000 per month (20 per cent savings ratio) for retirement lifestyle, it leaves $3,000 per month for debt servicing for home and car. If $1,000 per month goes to repaying a conservative $60,000 car loan over five years, the cash available for home loan repayment is $2,000 per month. Let's add $1,000 per month in CPF Ordinary Account available for servicing the home loan.
The numbers work out to conclude that a 40-year old couple who aim to be debt-free in 20 years can only take a mortgage of up to $500,000 if they direct $3,000 per month in cash and CPF to home loan repayment. Even if they had $500,000 from the net proceeds from the sale of an HDB apartment at age 40, Jack and Diane cannot afford to buy a home valued at more than $1 million. If they gave up their car, perhaps they can stretch their budget for a private home to $1.3 million. It is interesting to note that a bank may in fact be able to accommodate a monthly home payment of $5,000 and still be within the new lending cap, leaving nothing for retirement saving until the couple's salary rises. Delaying saving for retirement is a high risk strategy as the required return on investment over a shorter time horizon will be considerably higher than if one started investing early in life.
At today's prices, when a hot-selling new project with built-in area of 1,100 sq ft such as Jewel@Buangkok is priced at $1,200 psf, it's hard to imagine how a family of four plus a helper can fit in comfortably in an apartment such as this. Perhaps this is why ECs (executive condos) are so popular for middle-income families when you consider value for money. On another note, the property value to income multiple in this instance is in excess of 10 times if Jack and Diane proceed with a home priced at $1.3 million when the historical norm for the multiple was six times or less. The only logical conclusion to be drawn from present day consumer behaviour is that home and car ownership take precedence over planning for financial independence at a time when these lifestyle assets are terribly sought after.
Investing for retirement funding
The last piece of the puzzle is how to invest the monthly savings for retirement. There are four primary objectives for investing: capital growth, liquidity, safety of principal and income generation. Mutual funds and direct shares are modes of investing for growth in assets (but not without its risk) that can be liquidated for changing goals or circumstances. Real estate can be an investment asset class if the investor has adequate liquidity for short-term goals. Our client experience has shown that an average annual total return of 6 per cent in the accumulation phase is necessary to arrive at the "Magic Number". Gen X Singaporeans with combined income of $10,000 per month may need a capital of at least $3 million in liquid assets by the time they commence their drawdown phase in 20 years' time. Sadly, in this case study, Jack and Diane will have to sell their home at age 75 (see chart) to fund their retirement till age 90.
If you start with the end in mind, clearly the long-term goal of financial independence takes precedence over excessive home purchase and car ownership in Singapore. The margin of safety requires our personal TDSR to be no more than 50 per cent. This should give families a fighting chance of saving and investing 20 per cent of their income. One manner of investing is through a portfolio of diversified equities, bonds and global Reits (real estate investment trusts). Liquid assets with a growth strategy will guide smart investors in a low-growth environment of rising borrowing costs and moderate inflation. Relegating retirement planning to the back seat is bound to cause distress when you run out of time.
Projections of capital accumulation and drawdown for Jack and Diane
Source: iFAST Financial
The red bars indicate the target values of liquid assets for the couple with $3 million as the Magic Number when they retire at age 60. However, due to debt servicing commitments and the inability to save more from age 40, money runs out at age 75 (blue bars turn negative) and Jack and Diane have to monetise their home at some point.
Unless higher income and commensurate increased savings take place fairly soon, this couple cannot afford both the car and the private property.
Their ideal TDSR is no more than 40 per cent. In all likelihood, this couple will have to delay drawing down on their retirement fund till age 65 as a result of the lifestyle they have chosen. Serious investment strategy for their liquid assets must be implemented immediately.
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