Azure School

Financial PlanningLesson 2

Reading materials

• Read chapters 7 to 10 of the book, Practical Guide on Financial Planning, written by Mr. Tan Kin Lian

Invest your savings

• You should aim to get a yield that is at least 2% higher than inflation rate.

• If inflation is 3%, aim for a yield of 5%• The best investment is in blue chip shares, i.e.

large, well-established companies• The yield on blue chip shares over the past 20

years was 9.2% per annum.

Invest in an index fund

• A good way is to invest in an index fund, such as the Straits Times Index Exchange Traded Fund (STI ETF) traded on the Singapore Exchange

• This fund is invested in the top 30 leading companies in Singapore, i.e. blue chip shares

• It gives an average dividend of 2.5% and provides capital appreciation over the long term

• An index fund provides diversification of risk, as you are investing in many shares.

Invest for the long term

• You will be investing for the long term, i.e. for the rest of your life

• The investment horizon is likely to be 30 to 60 years.

• You do not need to worry about market volatility when investing for the long term.

• You will be getting the average yield for the good and bad years

Dollar cost averaging

• During your working years, you are saving and investing a small sum each month

• After you retire, you are withdrawing a small sum each month

• You do not need to worry about the market price, as the amount of investment or withdrawal is small.

• You will be getting the benefit of dollar cost averaging.

Investing on your own

• If you are knowledgeable in investing, you can invest on your own, instead of investing in the index fund.

• You should focus on shares of companies that you know, preferable the blue chip shares.

• It is better to invest 80% of your savings in the index fund an the remaining 20% of your savings in selected investments that you are familiar with.

Structured Products

• Structured products are created and sold by the banks and are well marketed.

• These are usually too complicated for retail investors

• Some are risky and have caused large losses for the investors. Others have given a poor return to the investors.

• If you do not understand these product, it is best to avoid them

Return on asset classes

• The average yield on different asset classes over the past 20 years (up to 2006) were:– Singapore equities 9.2% p.a.– Global equities 7.7%– Global bonds 5.5%

• Generally, equities give a better yield compared to bonds. This is the experience in many countries and over a long period of time.

• For the long term investor, it is better to invest in equities, especially blue chip shares.

Low interest environment

• The yield on investment had been quite attractive over the past 20 years

• However, we have been experiencing a low interest rate environment in recent years.

• For the future, we can expect the investment yield to be lower. This is the view held by many investment experts.

• Nevertheless, the yield on equities is still likely to be higher than bonds

Your CPF savings

• You get the following interest rate on your savings in the CPF:– Ordinary account 2.5% per annum– Special account 4.0% per annum

• The interest rates are subject to review by the CPF every quarter. It has been kept at this level for many years

• You are allowed to invest the savings in some approved investments. If you do not intend to buy a home soon, you can the ordinary account in the index fund to earn a higher yield.

Supplementary Retirement Scheme

• You are allowed to invest your savings under the Supplementary Retirement Scheme (SRS).

• Your SRS contribution can be deducted from your taxable income and reduce the tax payable

• You are allowed to withdraw your SRS savings at any time after age 62

• Half of the amount withdrawn has to be declared as taxable income; however the rate of tax for a retiree is likely to be low

• If you are a tax payer, you can use the SRS to reduce your tax bill.

• If you are in the higher income bracket or over 50 years, you should consider the SRS as a tax saving scheme.

• You should get financial advice of the potential tax savings, as it affects different people in different ways.

Unemployment

• If you are unemployed, you can draw down on your emergency fund or your savings fund.

• You may need 3 to 12 months to find an alternative employment, and may have to accept a reduction in earnings.

• It is best to prepare for this contingency, as it is likely to affect many people in the global world.

Education

• Your savings fund can be used to pay for the education cost of your children or for your own education.

• There is no need to set up a separate fund for each person. It is best to draw down from your own savings fund.

• Be prudent in using your savings fund for education.

• Many people spent too much money on education which does not have a payback.

Medical Expenses

• You can use your savings fund to meet the large medical expenses of your family or your parents.

• The small medical expenses come out of your current earnings.

• Make the best use of the government subsidized wards to reduce the medical expense.

• Before going for expensive private treatment, check the cost and avoid spending money on futile treatment, i.e. do not lead to a cure.

Retirement

• At least 50% of your savings fund should be kept for your retirement.

• When you use your savings fund for unemployment, education or medical expense, you do not need to repay back the money used.

• Make sure you keep sufficient savings for your retirement, i.e. 6 years of your income.

Investing after retirement

• After your retire, you can continue to keep your savings invested in the index fund.

• You can draw out the dividends for your retirement needs.

• If the dividends are not sufficient, you can sell of some units of the index fund to supplement the dividends.

A life annuity

• You have the option to sell off the investments in the savings fund and use the proceeds to buy a life annuity from an insurance company.

• In most cases, you are better off to continue investing on your own, rather than buy an annuity.

• You will enjoy more flexibility and a higher yield from the index fund.

CPF Life

• You will be required to invest your special account in CPF Life, which is a life annuity managed by CPF.

• You have the choice of the basic or standard option. Find out the amount payable under each option and decide on which is more suited to your needs.

• The payout from CPF Life is quite attractive, and is better than a life annuity sold by an insurance company.

Life expectancy

• The life expectancy at age 65 (based on 2008 data) is– Males 17.4 years– Females 20.8 years

• Most people can expect to live for 15 years or longer on retirement at age 65

• The life expectancy continue to increase as the years go by.

Term Insurance

• Term insurance is a low cost way to provide financial security for your family.

• This policy will pay the sum assured in the event of premature death. There is no payback at the end of the term.

• You can buy insurance for 5 to 10 years of your income. Choose a term of 25 years or less, to enjoy a lower premium.

• You can get $300,000 of insurance for an annual premium of $500.

Medical expenses

• Do not worry too much about medical expenses.• If you are working, the medical expenses may be

covered by your employer• You can buy the basic Medishield offered by CPF

to cover the unexpected large bills.• After your retire, you can pay the medical bills

from your own savings.• There is no need to pay a higher premium for a

Private Shield.

End of lesson 2

• Read the chapters of the book again in more detail.

• When you are ready, you can do the Quiz.