In investing, things are most of the time not definite.

I make a very poor salesman because straight away, people can detect a lack of confidence. I would rather say, my face most of the time, show how uncomfortable I am with things.

That is why we have advisers because they don’t have this problem of mine. At work, I kept the deepest, darkest part of what I know about the markets and investing firewalled from them.

This is so that they can function. If you know too much, it affects your ability to push a good narrative.

My friends who teach investing courses, trading courses probably cannot share too many of these uncertainties. Placed enough uncertainties in a prospects head and they will not make a decision.

Outside of these two groups, I hear folks having high conviction in companies that will never die, strategies that will always work, REITs that will always be better.

Not sure if others feel the same way, but in the active investing world, seldom do you get a feeling an investment feels permanently safe.

In the past, I shared that you can build conviction in a stock, or a trend by digging deeper into the numbers and doing deeper qualitative analysis.

When I do more, I generally feel much more comfortable in putting money to work.

But I never had that “this will sure work” kind of feeling. The posture is always: “Think this is safe enough. Got enough margin of safety. Lets get invested. See how it goes.”

When prices starts to change, when events starts unfolding, it becomes: “Ok this is getting safe, let’s add more.”

Or “Shit man, this feels like a possible train wreck results coming up.”

I never felt things are definite. This is why I admire people who could have high conviction that

1. Certain sect-oral trends would ALWAYS work


2. This company will WILL survive


3. This investing system WILL work

I dunno. Maybe I am a low confidence, risk adverse character by default.

I feel a lot of confidence people have is based on past history.

And today’s sharing might give a different perspective. We cover things passive investors, active investors and retirement planners can relate to.

The Limitations of Relying just on Numbers

The protagonist of this article (What I Learned From Losing $200 Million) eventually got a promotion and a great bonus. In the eyes of most people in the firm, he did so well and should be held up as a successful case study for others to follow.

I learn to have enough vulnerability to fully based investing decisions on my fundamental analysis after reading this article. Well, I had enough vulnerability before this, but this article really hits home the fact that if you do some really thorough work, if your framework has weaknesses, your investments will sometimes suffer from serious capital impairment.

Bob Henderson worked for a major investment bank during the 2008 financial crisis. He had a serious unrealized loss position to the tuned of $200 million at one point. In this article, Bob takes us through how he sees this deal. His firm largely viewed this deal as successful.

This is not a story of a trader that took a lot of risk and finally made a really bad trade that cost the firm. Bob describes their firms system as a collective effort. Bob was a physics trained PHD. He was hired for his skill in modelling.

By 2008, he has spent the past 10 years developing derivative and trading strategies. By and large most of the trades was successful. Bob thinks that his edge was not in predicting the future but simply for being careful and logical and systematic.

That sounds like what a lot of us want to think ourselves to be.

His models have worked for 10 years. This means that it has prevented large eventual trading losses. But 2008 was the first time he encountered the extreme tail end events.

His modelling is suppose to give the team a sensing of how much shit the open positions are subjected to.

His team’s models is mainly based on historical data. You can read the details of the trade from the article (it gives you a glimpse of why it is likely we may not be able to put out such trades by ourselves)

Bob would like us to think that his team’s models are very comprehensive. But that did not prevent his team from losing $20 million, then $30 million in 2 days. His model will show him that he is destined to lose even more money.

Until this point I’d managed the deal almost entirely on my own, making the decisions that led to where I …we… were now. But after a black cab ride from Heathrow to our Canary Wharf office, I got the guys off the trading floor and into a windowless conference room and confessed: I’d tried everything, but the deal was still hemorrhaging cash. Even worse, it was sprouting new and thorny risks outside my area of expertise. In any case, the world was changing so quickly that my area of expertise was fast becoming obsolete. I pleaded for everyone to pitch in. I said I was open to any ideas.

As I spoke, I noticed that one of the guys had tears welling up in his eyes. I paused for a second, stunned. Then my own eyes started to fill from a sudden wash of gratitude and relief that came, I think, from no longer being alone.

Basically, the math models stopped working in real world.

Historical Data Gives Us an Illusion of Control

Bob explains to us some of the frailties of using historical data.

I am trying to risk managed future situations with historical data. If the result shows that the probability of a high impact event is very, very low, I feel safe. If the maximum loss that I could suffer is still a manageable sum, I feel safe.

By doing this, I am expecting the future to be very similar to the past. In Bob’s case, 2008 presented real world events that is not contained in past data.

So what was once thought to be low impact, or very very low probability, became a reality and the models could not handled it.

Our models based on historical data makes us feel safe.

It gives us an illusion of control.

Bob thought he had good control for 10 years, until this one event showed him that maybe it is an illusion.

I understood immediately, having spent countless hours over many years struggling to extract probabilities and other forward-looking metrics from historical data.

The biggest challenge was always that the answers depended so much on which timeframe you focused on. The past month? Year? Five years? And if you want to use data to estimate the probability of a very rare event, then you need a lot of data—the more rare, the more data—which means taking data from further back in the past, and the further back you go, the less relevant it probably is.

But what’s the alternative to estimating probabilities? If we can’t say anything about what the probabilities are, then we really are forced to worry about the absolute worst possible scenario. A trader would never sell options or short stocks, since his losses could be infinite. People would avoid cars, planes, marriages … everything really, for fear of the worst possible result. We’d all be paralyzed.

This Explains why Most Money is in Fixed Deposits and Properties

For many of us, we want to ensure things are very very safe (to ourselves) before we can take the plunge.

One of the lesson I learn from this is that the future may rhyme like the past, but it is never the same.

And therefore you can never feel comfortable.

As investors, we try to search for the holy grail:

1. A very decent positive expected return


2. Low volatility


3. Low effort


4. Low cost


5. Very safe. There is no blow up or not a scam

What if, it does not exist?

For a lot of people they just became paralyzed. They do not invest. They leave their money in what they considered as “very very safe and decent return places”.

These are the fixed deposits, and property. By what they know from the long history.

Guessing in a Forward Looking Uncertain World

Bob realized his models were not working. It is just telling him things will only get worse.

He needs to find another way to save himself (and the firm)

He gives us a hint that the answer lies in Bayesian Networks. Bayesian Networks tries to gain inference by looking at the probability of events depending on other events.

It feels to me like its a systematic guesswork.

At this point, I agree with that thesis.

I realized, what saved my wealth from numerous occasion of potential blow-ups was not just the fundamental analysis but making the kind of dependence guessing.

For example, competitors results are not looking so good (or looking very good). Given they are in the same industry, and what we know about the company’s potential, there is every chance this company will not do so well (or do better).

It is guessing after doing a lot of fundamental work.

Guessing has a Cost to It

The cost of guessing is that unless we are very sophisticated, we cannot always get it right.

To guess well, you got to be very in tuned with the company to make that guess. A lot of investors make guesses and say it doesn’t work. That is because they don’t really know that company (despite they claiming they “done the homework”. Basically not in depth enough)

If you know the health of a company, its earnings potential in the past, and learn about the industry, you could increase your probability of success in making a good guess.

For those who preached passive investing in a portfolio of low cost funds, they believe that even folks like myself cannot outguess the market well over time.

I generally think that way.

The cost is that if you missed the best 50 days in the market, your average compounded returns might go from 7-8% a year returns to negative a year.

The opposite is also true. If you missed the worst 50 days, your returns will look much better.

However, the key thing is… if you are truly risk adverse, missing out on the worst days increases the chances of you staying in investing for the long haul.

Passive investing in a way is betting that future looks pretty much like in the past.

Dealing with the Weakness of Using Historical Data in Retirement Planning

If you ask me what I will recommend for your wealth building or retirement, I would say a broadly diversified, low cost portfolio.

You can get cash flow from it for retirement or financial independence.

Then you will ask me how safe is this strategy?

Well, this post probably show you the weakness.

Many also asked me whether spending an initial 4% of your initial capital in retirement, then subsequently adjust that initial first year spending by inflation is a safe spending method.

Well, this post probably show you the weakness.

You will move on and try to find the next holy grail in investing or retirement.

You will probably not find it. And would find an active boutique fund, or a dividend income strategy that gives you that illusion they have more control over these uncertainty than my suggestion.

The reality is that… the future is uncertain:

1. The banks where your fixed deposit are in, have every chance of blowing up


2. Your property’s future growth rate might be very different from in the past, on a secular basis


3. Your unit trust dividend income is based on the earnings and capital appreciation of the fund. If the performances lags, dividend income goes down. If you need $1000 a month in dividend income and the fund gives you exactly $1000 a month, and you cannot live on less, you are screwed

My counter to your question whether these are safe is… what is your alternative?

There are some safer alternative:

1. Build a bond ladder of high quality bonds or a bond fund with high quality


2. Use Inflation Protected Bonds


3. Use a less than 2% initial withdrawal rate

All 3 have similarities. They are very safe, likely takes care of inflation, but also need a lot more money.

So the solution to a lot of problems is having more money.

Summary

The value of Bob’s sharing for me is to lay out some of the uncomfortable things I feel in active investing.

The future is uncertain. But a lot of the time, the future rhymes with the past.

Whether it is investing, or retirement there are no ultimate investment, super safe stock or safest retirement strategy.

You just need to get better at understand and living with these things. Understand very well how things work, mitigate, transfer or accept the risks that come with it.

DoLike MeonFacebook. I share some tidbits that is not on the blog post there often. You can also choose to subscribe to my content viaemail below.

I break down my resources according to these topics:

1. 
   Building Your Wealth Foundation– If you know and apply these simple financial concepts, your long term wealth should be pretty well managed. Find out what they are


2. 
   Active Investing– For the active stock investors. My deeper thoughts from my stock investing experience


3. 
   Learning about REITs– My Free “Course” on REIT Investing for Beginners and Seasoned Investors


4. Dividend Stock Tracker – Track all the common 4-10% yielding dividend stocks in SG


5. Free Stock Portfolio Tracking Google Sheets that many love


6. 
   Retirement Planning, Financial Independence and Spending down money– My deep dive into how much you need to achieve these, and the different ways you can be financially free


7. 
   Providend – Where I work doing research. Fee-Only Advisory. No Commissions. Financial Independence Advisers and Retirement Specialists. No charge for first meeting to understand how it works

The post The Illusion that Your Investment Strategy is Safe appeared first on Investment Moats.

If you would like to post some rather vulnerable rant about the CPF on your social media, you got to recognize a few things:

1. 
   The CPF team picks up these things rather fast. This may make people abuse the social media as a way to get their unreasonable request through


2. 
   CPF have a serious trail of where every $1 that goes into your CPF goes. This means
   
   
   1. Into which account whether it is RA, OA, SA or Medisave
   
   
   2. If it is paid out, when it is paid out
   
   
   3. Where every dollar comes in originates from, whether it is a voluntary top up, retirement sum top up, or from your employer or employee contribution
   
   
   
   

I am not sure if there is a need for this level of sophistication but in a way, in some situations it does help.

There is this little incident that got picked up in the media.

A certain Mr Toh Thiam Hock Michael was voicing his displeasure that he is only getting $15 back in his POSB account. While his HDB is fully paid up, there are much utilities that he has to pay.

Mr Toh probably is the generation that is still under the old Minimum Sum Scheme (MSS) instead of our FRS, BRS and ERS. Instead of CPF Life, once activated, CPF will pay out a certain fixed monthly sum depending on how much he has in his CPF.

CPF provides a Response

CPF picks up these kind of chatters damn fast.

And here is their response:

No truth to allegation that most of his CPF funds were transferred to MediSave without authorisation. His Retirement Account had already been depleted following monthly payouts to him since 2013.]

Mr Michael Toh Thiam Hock claims that most of his CPF savings had been transferred to MediSave without his authorisation. This is not true. If there were such transfers, it would appear on his CPF statements.

In February 2019, in response to Mr Michael Toh’s allegation that his CPF savings were locked up, we had informed him that although he does not have enough CPF savings to meet his cohort Basic Retirement Sum, he is eligible to make a withdrawal of about $10,000 from his Ordinary Account (OA) and Special Account savings. To date, he has not applied for his lump sum withdrawal.

Like all CPF members, Mr Michael Toh’s CPF contributions are allocated to the Ordinary, MediSave and Special accounts for his housing, healthcare and retirement needs. We note that he has used over $86,000 of his CPF savings to meet these needs. Over $54,000 was used for his flat which is now fully paid up. Mr Toh has also withdrawn over $9,000 from his Retirement Account (RA) since 2013. Although his RA is now depleted, he continues to receive $15 monthly due to the government paying extra interest on his OA savings.

Like all homeowners, Mr Toh may wish to enhance his retirement income through options such as (a) renting out a room, (b) right-sizing his flat, or (c) selling a portion of his flat’s lease back to HDB under the Lease Buyback Scheme. HDB officers are available to guide him through the process.

– CPF on Social Media

You can see their response is as dry as it can be.

What we are also able to observe is how clearly CPF knows where each of Mr Toh’s CPF dollar goes to. Mr Toh has an option to take out, which means he has money.

While he does not meet the minimum sum, he is still able to take them out over time.

A Different Rant in February this Year

During the response in Feb this year, Mr Toh’s gripes is a little different:

From the CPF statements it can be seen that he has $66 to $67k in his CPF accounts last year. This is far higher than what is in the Medisave account.

The most important thing is that Mr Toh is getting $250 a month in payout from CPF Retirement Account. But the account is running out of money.

Mr Toh’s gripe then was: Why do you keep so much of my money locked away?

Further Checks on Social Media

Mr Toh’s private life from what I can see…. is deeply concerning.

He has this political slant that seemed to be not too happy with the incumbent. If you are interested, you can do a search up his name and it should bring you to that page.

But my biggest take away is this post:

I am not sure this is a satire post, or him being sarcastic. Honestly, after this series of post, I lean towards not trusting what he says most of the time.

But if you wish to come up with a coherent narrative, why follow up a post of you not having much money to pay your utilities, with a post of not having passive income non-stop?

These Rants is Likely to Backfire Badly for Him

Mr Toh does not realize that it is these kind of rants that is going to eliminate rather than advanced what he leans towards.

They feel that the government is out of touch with society. But I do think they are the one that is out of touch with society. Especially the younger ones.

He has generated a whole narrative by posting some negative comments, and then see the whole social media tearing his argument apart.

People look at this whole story and think: “Wah liew, I better don’t turn into folks like this next time.”

And those who view him associate the behavior of the parties that he leans towards to be the same as him.

People wishes to be seen as able to make logical choices. The more we have these kind of episode is going to hurt them more.

And it seems, folks like Mr Toh is really out of touch with a key part of the society, not the government.

DoLike MeonFacebook. I share some tidbits that is not on the blog post there often. You can also choose to subscribe to my content viaemail below.

I break down my resources according to these topics:

1. 
   Building Your Wealth Foundation– If you know and apply these simple financial concepts, your long term wealth should be pretty well managed. Find out what they are


2. 
   Active Investing– For the active stock investors. My deeper thoughts from my stock investing experience


3. 
   Learning about REITs– My Free “Course” on REIT Investing for Beginners and Seasoned Investors


4. Dividend Stock Tracker – Track all the common 4-10% yielding dividend stocks in SG


5. Free Stock Portfolio Tracking Google Sheets that many love


6. 
   Retirement Planning, Financial Independence and Spending down money– My deep dive into how much you need to achieve these, and the different ways you can be financially free


7. 
   Providend – Where I work doing research. Fee-Only Advisory. No Commissions. Financial Independence Advisers and Retirement Specialists. No charge for first meeting to understand how it works

The post This Latest $15 CPF Rant is Going to Turn Rather Badly appeared first on Investment Moats.

This week is pretty much drained. So I don’t have any bandwidth to explore things that are new. Weekends is probably to catch some breath.

One of my reader that I met up with some time ago asked me these 2 deeper question about retirement:

1. What amount of principal will you feel comfortable to quit the job & just collect investment dividends, with a not-too-spendthrift lifestyle?


2. How much to “reserve” for medical costs?

I thought it is easier to tackle in this week that requires some decompression.

A Framework to Think about Whether You are Ready for Retirement

Before I shared my answer to some of the questions, I would like to give a shout out to a reader (a different one from above) I met this week.

Sometimes talking to others interested who are interested in similar stuff, would make you realize a perspective that you didn’t think of in the past. So I got to thank him for that.

My reader, in a spectrum of Singapore wealth, put himself in a good position to consider retirement. I find that he has taken care of a few aspect that others would have been struggling with. So the questions are more deeper and harder to give an answer.

Both readers (this and the one asking the question above) questions all revolve around true retirement readiness.

True retirement readiness is not some 10 to 15 item article that after you go through them, you still feel something is missing. It is that if you get passed those hurdles, you should be ready to pull the plug.

It has to be said, that this is for the risk adverse. Because for the risk seeking, don’t like their job, or when the work pain gets much higher than the threshold, they just pull the plug without thinking so much.

I do not profess I have the answer, but this is what I thought about:

My Retirement Readiness Framework

This is roughly how I would explain it.

1. Your True Financial Situation

Suppose we know the true state of our financial situation, we take an important step towards retirement.

In true state, you know

1. the exact lifestyle that you want in retirement


2. how your expenses change over your retirement


3. what are the unexpected expenses, or lifestyle that will occur in a few different people’s retirement


4. the true state of your financial assets and liabilities


5. the interest you have to pay for the debt


6. to a high degree, you know the compounded rate of return of your wealth.

When you know the true state, if the retirement mathematics work out for you, this takes care of the mathematics side of things.

2. The Non Monetary Aspects

A lot of people consider the non monetary aspect of retirement to be easy.

The non monetary aspect could be

1. whether you made peace with your professional identity


2. how the society looked at you


3. what you are going to do for the next phase of your life


4. have you been responsible to those who helped you professionally

These items are needed to be considered. Less careful considerations may mean returning to the work force. These are not deal breaking, or life ruining.

3. Your Experience with Wealth Management

My conversation with my reader made me realize the wealth management part is rather crucial.

I realize in some of the past conversations with others, a common problem was finding out a better way to accumulate wealth, or an appropriate way of investing so that it is more conducive for retirement spending.

He has been living with his investing strategy for the past 6 to 8 years. It is one which is based on portfolio allocation and delegating the investing to fund managers.

I do find that he is more ready for this because he is comfortable living with this way of wealth accumulation. This method of investing is also more sensible in spending for retirement.

Without talking to my reader, I failed to realize that one of the reasons why I think this (financial independence) is doable is because I have been investing for years. To extend this into retirement, this looks doable still.

For others, I realize they have the net wealth. However, they are uncomfortable with the way they allocate their net wealth. It is either not high return enough, or it does not cash flow enough.

If we recommend a new investing method that meet the criteria, they will have the uncertainty whether the returns, the volatility will work as advertised.

This uncertainty will make them second guess whether they are ready.

What would retirement feel like if you have not taken care of these three aspect?

There will be different degree of comfortableness living in retirement.

For some, they might eventually become comfortable with this way of investing and getting their retirement cash flow this way. For some, they might just felt that what they have chosen is not sustainable.

If your financial situation is not the true situation, you might suddenly realize there are too much things you have not factored in, your spending is too much and you will need to go back to work soon.

We have briefly went through the non monetary aspects and I think that is enough.

Of course, it may turned out that your true financial situation and investing strategy are really sound, then your retirement would be better than you have anticipated.

Would a Financial Planner Helped?

The financial planner would take care of helping you assess your financial situation. Whether the assessment tells a person the true state of their retirement readiness, I feel, is a matter of competency.

My personal opinion is that non of us can find this true financial situation. If we can consider a lot of realistic scenarios and our numbers looked OK, then it is good to go.

The world is constantly changing, your life is always evolving, so all these parameters will keep changing. Someone sophisticated enough will considered enough and explain to you that you should be ready or not.

My belief is that not many will give a good view of your financial situation.

You could delegate the investments portion away to a professional. However, you will have to learn to live with such an arrangement. Delegating away solves the investing stuff, but you may not know how to live with investing this way.

When your adviser reports this fund and that fund dropped 20% and 30% respectively, what do you do? Those who learn to live with it, gain competency, would be able to make a decision to switch or to stay with the fund. Those who have not learn enough would get really edgy with their retirement.

Some advisers who have enough experience would be able to make you appreciate the non monetary aspect of things. However, I think for that portion it is best for you to figure out yourself.

What amount of principal will you feel comfortable to quit the job & just collect investment dividends, with a not-too-spendthrift lifestyle?

My answer to this question is unique for myself and might not work for others because my:

1. the way of investing is different from you


2. financial situation is different


3. the non-monetary aspect is different

I went from being very spreadsheet based to just figuring out with withdrawal rates.

It is very simple. Every month, if the portfolio value change, I can just look at the withdrawal rate and know this is OK, this is not OK.

Very simple. Don’t need complex spreadsheet. I can do that because… let me just say I looked at enough Monte Carlo simulations, withdrawal rates arguments, historical simulations that it affected me this way.

No professional will tell you with a single ratio, you are financially ready. So it only works for me.

So here is a rough fast walk through of how I do it:

1. Appreciate your Lifestyle and Expenses

To even begin this you need to know your expenses and lifestyle well. You can take a look at my past annual expense reports.

If you don’t know your expenses or lifestyle, think don’t bother to continue to read this.

2. Categorize your expenses into 4 categories

Your expenses can be broken up into the following categories:

1. Non-Recurring Essential Expenses


2. Non-Recurring Non Essential Expenses


3. Recurring Essential Expenses


4. Recurring Non Essential Expenses

The Non-essential expenses, they are good to have. If your portfolio is not doing well, cut them by 25%, 50%, 75%. If it does well, boost them or take harvest of this so that you can spend it when times are not good.

The essential expenses, you have to make sure that they are there.

The non-recurring expenses are not going to take place every year. In other countries, roof needs to be replaced. Locally, your home needs a 15 year once renovation for example. These are essential but non-recurring.

Even healthcare can be considered non-recurring.

For the non-recurring expenses, figure out the present value of these non-recurring expenses. I will go through this later with the medical sinking fund question.

3. Create a few Lifestyle Schemes

Once you figure this out, create a few lifestyle schemes for the expenses.

I created the following:

1. 
   Survival: Recurring essential expenses only


2. 
   Baseline: Recurring essential expenses + 25% of recurring non-essential expenses


3. 
   Current: Recurring essential expenses + recurring non-essential expenses

Survival is for me to figure out in the worst of the worst case, whether I can survive as a human being. Baseline is a lifestyle that I feel comfortable in living for a long time. Current is how I am living now.

If you need to live like what it is like currently in retirement then #3 will be the most important for you.

4. Deduct the liabilities from your portfolio

When you go through the expenses and find the non-recurring essential and non-essential expenses, these are the contingent liabilities that you need to set aside money for.

This will come from your net wealth, or from insurance.

For example, you can compute the present value of all your vacations. They are likely non-essential and non-recurring. Then you can get the present value.

If you are adverse to dementia and would like to prepare for it, estimate when you will get it and for how long. Get the present value for this.

Take your net wealth, deduct these 2 present value (vacation and dementia) from it.

5.Calculate the initial withdrawal rate from the net wealth

For those 3 schemes (Survival, Baseline, Current), you can take the annual expenses / net wealth left after deducting the liabilities.

If your withdrawal rate is low enough for you, congratulations, you are ready numbers wise.

To circle back to my original framework, you probably have to take care of the wealth management and non-monetary aspects.

This table below shows the decision tree whether you are ready to retire or not, and if not, what is the recommendation:

Click to see Bigger Decision Tree

My Withdrawal Numbers:

The Survival Withdrawal Rate is probably 1%.

The Baseline Withdrawal Rate is probably 1.3%.

The Current Withdrawal Rate is probably 1.7%.

Do note that I have not deduct much non-recurring expenses. I treat most of the expenses as recurring. What this means is that the numbers might look a little different.

You can look up that decision tree chart above to see what are the recommendation for myself.

Typically, the recommendation is to ensure you are able to guarantee to have a cash flow for your survival expenses. This will mean you have a withdrawal rate of 3% or less. If you are conservative, the baseline withdrawal rate can aim to be less than 4% if your essential expenses are covered well below 3% ( this will mean you spent nearly 1% on 25% of your non-essential recurring expenses)

Medical Sinking Fund

The question of medical sinking fund is damn tough.

Medical budgeting is so tough that even Lee Kuan Yew School of Public Policy took it out of their paper. (Read this)

As a planner, you have no choice but to try and model this, if you feel that you need to factor this in.

I would break up the expenses into:

• 
  Recurring essentials: The medicine you have to take daily in order for your condition not to become bad, insurance premiums


• 
  Recurring non-essentials: The supplements that are good to have


• 
  Non-recurring essentials: The medical sinking fund for conditions that are likely to happen in the future.


• Non-recurring non-essentials: if there is any

The recurring portions will go into the expense schemes I have explained previously.

Determining the Non-Recurring Essentials

I thought about this at work and it can be rather tough to determine. Do you just keep adding so many contingent liabilities?

An adviser shared with me that if you get disabled, a lot of the other expenses might come down. If you keep adding these contingent liabilities together, think you can continue to work in an unhappy job for a long time.

Dementia Case Study

Likely we cannot find out the true costs. But if you have medical professional as friends, you can find out the probabilities, frequency of occurrences, and how much it costs.

Then you can get the present value, figure out the rough amount you need today.

For example, you are 41 years old. Suppose someone similar tomorrow gets dementia and needs to be admitted to a nursing home.

This form of estimation is probably the most extreme. The idea is that, if you managed to provide for this scenario, you should be able to take care of the smaller ones.

Typical cost of nursing home comes up to $4,000 a month (if there are vacancies). That will be $48,000 a year. Suppose you are worried about inflation. Use 7% inflation. We invest the rest of the money in a portfolio that compounds at 4.5% a year. We estimate that this dementia patient survives for 60 years.

I found this awesome spreadsheet calculator and it gives the following result:

A 60 year surviving dementia patient

The awesome thing about this calculator is that it computes the payment at a different rate of growth from the investment rate of return, and when the payment is differed for a number of years.

The formula for present value is this:

=p*IF(i=k,(1/(1+i))^t*n,(1/(1+i))^t*((1-((1+k)/(1+i))^n) / (1-(1+k)/(1+i))))

In our base case, you will need a sinking fund of $6.3 mil.

Suppose you buy some disability insurance which hopefully covers this when you are before 65 years old. We differ the need for this payout by 25 years and we need the money for 35 years.

The present value is lower at $860,000.

If we estimate that onset of dementia happens after 65 and last for 10 years, the figures work out like this:

The sum becomes more manageable.

I feel it is better to figure out roughly how much you need. Like what my adviser friend said, your expenses may be cut down when you are this disabled. The net wealth can go to fund for this scenario.

Hospitalization Case Study

We do not know when we will be hospitalized. Each of us have different genetic profile. Some of us have pre-existing illnesses and so the frequency of future hospitalization are also different.

My suggestion is to plan out a few scenarios and see what is the sinking fund amount you can get to. Then you set aside this amount as a sinking fund.

Suppose we estimate that within a 60 year period, you will have 3 different levels of hospitalization:

1. Small: $3000 per visit


2. Medium: $30,000 per visit


3. Large: $300,000 per visit

This is before your hospitalization and surgical plan, or your shield plan. You will need to pay a deductible and a 10% co-payment at the minimum. Let us assume the deductible to be $3,000.

If we assume medical cost go up by 7%, you can come up with the following:

First Part of my Medical Cost Spreadsheet
Second part

We can see the year, age, deductible paid, the size of the actual bill for small, medium and large problems, adjusted for inflation. Then, we can work out the total deductible plus co-payment required.

Approximate the value back to present value in the last column.

This figure comes up to $289,000 in present value. Readers let me know if you have such a frequency of medical hospitalization. Every 15 years, there is a major surgery. Every few years there is a big one.

If you have $52,000 in your CPF Medisave, it means you need $237,000 more.

You can vary the frequency. What I can share with you is that, the small problem don’t move the needle.

Removing the major illnesses costing $2 mil and $6 mil cuts the present value needed to $124,000. Removing all the medium problems cut the amount to $66,000.

Play around enough, and you would have an appreciation how many major and medium problems you need to cater for.

Conclusion

This took longer than expected. However, I felt it was a nice exercise to go through trying to find out how much does our future medical cost will be in today’s dollars.

I will probably expand on the medical sinking fund idea, either here or in a work article of mine.

DoLike MeonFacebook. I share some tidbits that is not on the blog post there often. You can also choose to subscribe to my content viaemail below.

I break down my resources according to these topics:

1. 
   Building Your Wealth Foundation– If you know and apply these simple financial concepts, your long term wealth should be pretty well managed. Find out what they are


2. 
   Active Investing– For the active stock investors. My deeper thoughts from my stock investing experience


3. 
   Learning about REITs– My Free “Course” on REIT Investing for Beginners and Seasoned Investors


4. Dividend Stock Tracker – Track all the common 4-10% yielding dividend stocks in SG


5. Free Stock Portfolio Tracking Google Sheets that many love


6. 
   Retirement Planning, Financial Independence and Spending down money– My deep dive into how much you need to achieve these, and the different ways you can be financially free


7. 
   Providend – Where I work doing research. Fee-Only Advisory. No Commissions. Financial Independence Advisers and Retirement Specialists. No charge for first meeting to understand how it works

The post How Ready are You to Retire? appeared first on Investment Moats.

Both Straits Times and Business Times ran the update that DBS will be launching their Exchange Traded Funds (ETF) portfolio for the investors.

And it got me thinking about a few things.

Firstly, the product.

A Human-Robot Managed ETF Portfolio

There will be 2 portfolios that are launched:

1. The Asia Portfolio: Gives you Singapore listed ETF exposure to countries in Singapore, China and India


2. The Global Portfolio: Offers UK-listed ETFs

You can invest with a minimum sum of $1,000.

The investor will be charged an AUM fee of 0.75% per year. You can look at this as the company wrap fee.

There will be no more sales charges, locked in period or platform fees. More on this later.

The portfolio is actively managed.

A team of portfolio managers led by Mr Christophe Marciano, head of discretionary portfolio management, will review the portfolios on a quarterly basis to ensure that they remain resilient to market volatility, provide optimal returns, and remain aligned to DBS Chief Investment Office’s views.

So if we understand from this, this portfolio will be “actively re-balanced”, or “strategically allocated”.

Lower Cost than Unit Trust

Using exchange traded funds is great. But I do have to be clear. Using them is good because they are relatively low cost enough, versus the past competition such as unit trust.

Unit trust on average would have 1% to 2% in annual expense ratios, which are recurring costs. ETF listed in Singapore at least have below 0.75% at least. (this is not including commission, the AUM fees)

Cost is an important component because it eats into your return. If we go by past history, it is very difficult to make out-sized out-performance versus the indexes these ETF and funds are measured against. Thus, usually the best they can do is to keep up with the index they are suppose to outperform.

The above illustration is a favorite of mine to show that over time, the costs do eat into the returns, if the strategy does not generate an edge. Each of the lines is 7% returns plus different cost. You can think of them as your expense ratio and sales charges.

Your returns are uncertain, but your costs is always incurred, whether the fund does well or not.

It is not only ETF that can be lower cost than traditional unit trusts. Some unit trusts can be lower cost than the traditional unit trust. The Lion Global Infinity Series of Unit trust is a wrapper around Vanguard low cost unit trusts. Not super low cost by Vanguard standards but still lower cost enough. You can read my review of the Infinity Global Fund, which is one of the fund that tracks the MSCI World Index.

I written about the Dimensional funds in the past. That is also a low cost unit trust, but you can only buy it through an AUM structure. The Vanguard funds, available to accredited investors in Singapore, are also unit trust that is low cost.

I am not sure if the Active Management can Deliver Outperformance

DBS’s digiPortfolio is not the first that came up with the human + robo tilt. MoneyOwl brands themselves as bionic, which is roughly the same thing.

The difference is that there is a manager tilting the allocation of the ETFs in the digiPortfolio so that they give you optimal returns (what is optimal returns?) and controlled volatility.

MoneyOwl implements Dimensional funds, which are not passive as well. They rely on Dimensional’s deep research over the years, and currently, on what are the factors that gives pervasive and persistent out performance.

So the DBS manager is going up against a team that have been doing it for close to 40 years.

The harsh reality is that in the past 7 to 8 years every one’s returns pales to the S&P 500 or NASDAQ.

A lot of the value, size, momentum tilts was not working for a long time. If you are not in growth, you are rather screwed. What this means is that most of these manager’s tilt should under perform.

Since I track these things at work, I can safely tell you that Dimensional funds have been under performing the index they compared against. Not just that the funds such as Aggregate, Inclusif, Lumiere Capital, Lighthouse Advisers as well.

Source: DBS Treasuries

Perhaps the best way to think about this is in this way. Since they are actively managed, let us look at the performance of their unit trust portfolios for their higher net worth clients under DBS Treasuries (more on that later)

Slow n Steady, Comfy Cruisin and Fast n Furious should be 3 different allocations ranging from conservative, balanced to aggressive.

That half year 2019 returns look great. However, the market have recovered much from last year.

The best way is to measure against a model portfolio. It is strange that is not published but perhaps we can take reference from some of my model index portfolios at work.

These model index portfolios are made up of MSCI World, MSCI Emerging Markets, Bloomberg Barclays aggregate bond index. They are not what the clients invest in but what the funds are measured against.

2019 YTD up till June index benchmark model portfolio results are as follows:

1. Conservative (USD): 9.96%


2. Conservative (SGD): 9.15%


3. Balanced (USD): 12.20%


4. Balanced (SGD): 13.08%


5. Equity (USD): 15.42%


6. Equity (SGD): 15.49%

You be the judge. Do note that DBS did not put out a model index portfolio they benchmark against. If they do, please let me know.

The DBS unit trust portfolio actually did better than some of the boutique funds this year.

The Global Portfolio

I will not say much about the Asia portfolio because it feels… like another actively managed unit trust. There is a home region bias sometimes and for those who feels more at home in Asia, this may be up to your consideration.

The Global Portfolio is interesting in that they make use of UK Listed ETF. These ETF’s tend to be domiciled in Ireland, and for the international investors, there are some tax advantages. (I talked about these tax differences more in my Dimensional article and withholding tax article here). It has to be said, not all ETF listed in UK are domiciled in Ireland.

It shows that DBS is also paying attention to what the smarter local investors are doing here and what they are doing on DBS Vickers platform.

DBS have the opportunity to give investors a easier access to some of these low cost iShares or Vanguard ETFs.

What the more cost conscious investors will look to are

1. What are the underlying ETFs


2. How is the active strategic management carried out

I think we will know the fund details next time. So there are not much we can comment here.

The competition for sophisticated investors is not each of the robo invest firms but against the Gold Standard DIY Option.

The Gold Standard DIY Option is to invest in certain low cost, Ireland Domiciled, UK Listed ETF through Interactive Brokers.

The advantage of digiPortfolio is a much more stream lined interface. I do think for some very bochup investors, if the manager does a good job, there are certain advantages for them to manage their money through an active manager.

You would have to see if that is worth it over the cost difference of 0.75% per year AUM versus 0.05% per transaction cost. (for investors with lower sums than US$100,000, the cost difference might be lower. Refer to my dimensional article)

Could you RSP or GIRO into an ETF digiPortfolio?

Even till today, I do think why Insurance Endowments, Investment Linked Policies and Unit Trust sell well is because you can initiate a regular savings plan (RSP).

Once setup, the money will funnel from your bank account, to the unit trusts, ILP and endowment.

ETF transactions at Robo is still very clunky, perhaps with the exception of MoneyOwl and Endowus since they use unit trusts.

With RSP, the wealth building can be more passive.

When it is more passive, there is less behavioral tendency to act more rashly.

The Cost Comparison

I am not going to do a deep cost comparison because, frankly I am not in the mood to do that.

Comparing the full cost stack of a few Robos (click to view larger image)
Comparing the full cost stack of a few DIY solutions (click to view larger image)

You can however take a look at some of my past comparison.

Note that the 0.75% AUM fee is equivalent to the Company Management Wrapper Fee line item.

DBS likely is not absorbing the underlying expense ratio. This is the difference between DBS and OCBC’s All Seasons Fund (not listed up there). In that All Seasons fund, there is a company management wrapper fee of 0.50% but from what I understand, you are not charged the underlying fund expense for the Lion Global funds. You are for the non Lion Global fund.

The DigiPortfolio have an advantage over some DIY solutions because they have custodian fees, which is equivalent to platform fees. DigiPortfolio do not have platform fees.

For that they have an advantage over MoneyOwl as well because of iFast’s 0.18% platform fees.

Given that, if digiPortfolio give you a IWDA or VWRD, you can get invested at 1.05% in total all in cost (around 0.30% expense ratio + 0.75% AUM fee)

I think that is close to the Infinity Global’s cost, which is not too bad.

The Positioning of These 2 Portfolios versus The Global Portfolios

DBS have already rolled out 2 portfolios for the DBS Treasuries Clients. These are the clients with AUM of $350,000 (actually it can be lower because some of my friends with less money are inside)

These 2 portfolios, The Global Portfolio and Global Portfolio Plus, use actively managed unit trusts. For each there are 3 different bond and equity allocations.

The stuff that is in one of these unit trust portfolio

The ETF portfolio are positioned as more suitable for investors with no prior experience.

So I wonder what happens when the investor becomes more experienced. Should they switch to a Global Portfolio and Global Portfolio Plus?

The Robos have a certain philosophy and they implement it in their portfolio. Then they market one portfolio.

The banks have too many products.

Experience tell me different products suit different wealth builders of different nature. However, I find it hard to make out the distinct differences that a portfolio of higher cost unit trust suit you more than a low cost ETF portfolio (both are marketed by the same firm)

Personally, I think they just make those who know less even more confuse. Then they get on Seedly to ask XX, YY, ZZ which is better.

The Distribution Channel

The existing Robos have to burn a lot of money on advertising because they do not have an existing distribution channel. And still they would struggle with getting the sizable AUM to be profitable.

The banks and brokerage platforms have the distribution channel with their banks and customer service people. Not to mention the financial muscle. And it is this distribution channel that will make them gather AUM much faster than the Robos could.

The idea of investing has to be sold most of the time. Folks seldom wake up and have this idea that they need to invest.

But I do wonder, with Manulife’s 15 year bancassurance partnership with DBS, given the choice, which would their people push more for the every day people.

Perhaps after the initial spurt, interest would die down.

The Death of the Traditional Stock Broker Platform

At that time, it moved a number of its employees from DBS Vickers into the bank in an effort to cater to demand for a more holistic wealth proposition.

A few months ago, I started hearing the rumors of movements within DBS Vickers. It seems that DBS may have realized that they need to rationalize the brokerage business.

This digitization of investments may be it.

I have not received any notices whether my brokers are still around. Usually, I will email her via email. So I shot her an email just to test 2 months ago. Usually she will reply me with a call in the day.

No response.

Then last week, I received this Whatsapp message:

Hi XXX,
I’m YYY, your remisier from DBS Vickers (DBSV). I tried calling you and WhatsApp you since Aug 23 but could not reach you.
I enclose specimen letter and Transfer Request Form, in case you have not received them.
I shall be grateful if you will complete, sign and return the Transfer Request Form to me at my email address:

Apparently, UOB Kay Hian took the Remisers in.

UOB Kay Hian, the largest securities brokerage in Singapore, has emerged as a keen suitor for the 150-odd remisiers and retail equity trading representatives at DBS Vickers, the broking arm of Singapore government-linked DBS Bank.

Business Times

However, my confusion was what should I do?

Is DBS Vickers not going to be around anymore or not going to serve me? No sound at all.

Conclusion

I think at this stage, the UK Listed Global Portfolios look promising to what I advocate wealth builders with less time to do. But you should evaluate if you wish to go with Interactive Brokers as well.

It is not the most straight forward to use and I can see why people would go with a Robo despite costing more. The hassle of the onboarding and transaction process matters to some people.

We have to wait and see what is in the portfolios.

DoLike MeonFacebook. I share some tidbits that is not on the blog post there often. You can also choose to subscribe to my content viaemail below.

I break down my resources according to these topics:

1. 
   Building Your Wealth Foundation– If you know and apply these simple financial concepts, your long term wealth should be pretty well managed. Find out what they are


2. 
   Active Investing– For the active stock investors. My deeper thoughts from my stock investing experience


3. 
   Learning about REITs– My Free “Course” on REIT Investing for Beginners and Seasoned Investors


4. Dividend Stock Tracker – Track all the common 4-10% yielding dividend stocks in SG


5. Free Stock Portfolio Tracking Google Sheets that many love


6. 
   Retirement Planning, Financial Independence and Spending down money– My deep dive into how much you need to achieve these, and the different ways you can be financially free


7. 
   Providend – Where I work doing research. Fee-Only Advisory. No Commissions. Financial Independence Advisers and Retirement Specialists. No charge for first meeting to understand how it works

The post Some Thoughts on DBS’s ETF digiPortfolio appeared first on Investment Moats.

$DBS(D05.SI)

Here is a higher yielding, safe way to save your money that you have no idea when you will need to use it, or your emergency fund.

The October 2019’s SSB bonds yield an interest rate of 1.75%/yr for the next 10 years. You can apply through ATM or Internet Banking via the three banks (UOB,OCBC, DBS)

However, if you only hold the SSB bonds for 1 year, with 2 semi-annual payments, your interest rate is 1.64%/yr.

$10,000 will grow to $11,758in 10 years.

This bond is backed by the Singapore Government and its available to Singaporeans.

A single person can own not more than SG$200,000 worth of Singapore Savings Bonds. You can also use your Supplementary Retirement Scheme (SRS) account to purchase.

You can find out more information about the SSB here.

October 2019

Note that every month, there will be a new issue you can subscribe to via ATM. The 1 to 10 year yield you will get will differ from this month’s ladder as shown above.

Last month’s bond yields 1.95%/yr for 10 years and 1.65%/yr for 1 year.

Here is the current historical SSB 10 Year Yield Curve with the 1 Year Yield Curve since Oct 2015 when SSB was started (Click on the chart, move over the line to see the actual yield for that month):

The Application and Redemption Schedule

You will apply for the bonds through the month. At the end of the month, you will know how much of the bond you applied was successful.

Here is the schedule for application and redemption if you wish to sell:

Click to see larger schedule

You have 02 to about 25th of the month (technically the 4th day from the last working day of the month) to apply or decide to redeem the SSB that you wish to redeem.

Your bond will be in your CDP on the 1st of the next month. You will see your cash in your bank account linked to your CDP account on the 1st of next month.

How does the Singapore Savings Bonds Compare versus SGS Bonds versus Singapore Treasury Bills?

Singapore savings bonds, is like a “unit trust” or a “fund” of SGS Bonds.

But what is the difference between you buying SGS Bonds and its sister the T-Bills directly?

Both the SGS Bonds and T-Bills are also issued by the Government and are AAA rated.

Here is an MAS detailed comparison of the three:

Click to see bigger comparison table

What is this Singapore Savings Bonds? Read my past write ups:

1. This Singapore Savings Bonds: Liquidity, Higher Returns and Government Backing. Dream?


2. More details of the Singapore Savings Bond. Looks like my Emergency Funds now


3. Singapore Savings Bonds Max Holding Limit is $200,000 for now. Apply via DBS, OCBC, UOB ATM


4. Singapore Savings Bonds’ Inflation Protection Abilities


5. Some instructions how to apply for the Singapore Savings Bonds

Past Issues of SSB and their Rates:

• 2015 Oct


• 2015 Nov


• 2015 Dec


• 2016 Jan


• 2016 Feb


• 2016 Mar


• 2016 Apr


• 2016 May


• 2016 Jun


• 2016 Jul


• 2016 Aug


• 2016 Sep


• 2016 Oct


• 2016 Nov


• 2016 Dec


• 2017 Jan


• 2017 Feb


• 2017 Mar


• 2017 Apr


• 2017 May


• 2017 Jun


• 2017 Jul


• 2017 Aug


• 2017 Sep


• 2017 Oct


• 2017 Nov


• 2018 Jan


• 2018 Feb


• 2018 Mar


• 2018 Apr


• 2018 May


• 2018 Jun


• 2018 Jul


• 2018 Aug


• 2018 Sep


• 2018 Oct


• 2018 Nov


• 2018 Dec


• 2019 Jan


• 2019 Feb


• 2019 Mar


• 2019 Apr


• 2019 May


• 2019 Jun


• 2019 Jul


• 2019 Aug


• 2019 Sep

DoLike MeonFacebook. I share some tidbits that is not on the blog post there often. You can also choose to subscribe to my content viaemail below.

I break down my resources according to these topics:

1. 
   Building Your Wealth Foundation– If you know and apply these simple financial concepts, your long term wealth should be pretty well managed. Find out what they are


2. 
   Active Investing– For the active stock investors. My deeper thoughts from my stock investing experience


3. 
   Learning about REITs– My Free “Course” on REIT Investing for Beginners and Seasoned Investors


4. Dividend Stock Tracker – Track all the common 4-10% yielding dividend stocks in SG


5. Free Stock Portfolio Tracking Google Sheets that many love


6. 
   Retirement Planning, Financial Independence and Spending down money– My deep dive into how much you need to achieve these, and the different ways you can be financially free


7. 
   Providend – Where I work doing research. Fee-Only Advisory. No Commissions. Financial Independence Advisers and Retirement Specialists. No charge for first meeting to understand how it works

The post Singapore Savings Bonds SSB October 2019 Issue Yields 1.75% for 10 Year and 1.64% for 1 Year appeared first on Investment Moats.

The majority of the rich who got really wealthy took calculated risks. They also had the foresight to see things that a lot of us would not be able to see.

Rich people surround themselves with people more competent then them in areas they are not good at.

Most of the time, the wealthy was also able to execute their plans very well. You will also find them having the ability listen to others when it is time to listen. But be steadfast when they needed to.

I got very little of these traits.

And maybe that is why I am not rich (by today’s much higher standards). I worked in a firm where we steward our client’s wealth carefully, so I know where I stand in the spectrum of people who are rich and poor.

But I do think that I have enough wealth for myself though. Enough for me to have a conversation with you on this topic.

The pertinent question on your mind is:

Absent of luck or being born into an affluent status, how do you realistically become rich?

There are a lot of posts out there trying to let you in on this secret.

But there is really no secret.

I read enough money stuff for the past 18 or so years. Having invested my money and built wealth through active stock investing for 15 of those years, I became financially independent and have also written enough stuff on financial independence as a subject.

Most of my friends in the blogosphere became very much richer than when they started years ago by doing roughly the same things as I did. Some of my friends not writing, but building businesses distill it as pretty close to something like this.

We learn from a lot of our firm’s clients that is how they build their wealth and sustain their wealth as well.

The idea to become wealthier than you are now is quite simple. It is just that the information is all over the place. The tactics comes in different flavors but usually around the same point.

So this post sought to help you piece everything together, and add some comments on how I did when it in the Wealthy Formula (I didn’t do well in all areas!)

The General Idea to be Realistically Wealthy is in this Formula

We tackle the money side of things first.

The wealthy formula in a nutshell.

If there is one thing to remember, it is this diagram above. In your life, you will keep doing the things above over and over again.

1. You will increase the GAP or Personal Free Cash Flow

There is this gap between what you earn and what you spend.

We also call this the personal free cash flow. The bigger this gap, the greater your personal free cash flow.

Suppose after tax, I earn $60,000 a year.

My essential expense are the expenses that I need to survive adequately.

This will be

1. my meals at home and outside


2. meals for my family


3. my transport


4. phone utilities, home utilities


5. home maintenance


6. health insurance, taxes.

These essential expenses come up to $20,000 a year. So I have $40,000 a year left.

This is my free cash flow or GAP.

The greater your personal free cash flow, the more deliberate decisions you can make:

1. 
   Spend on entertainment, shopping and rich living. This may enhance your well being. Will not increase your net wealth


2. 
   Pay down your debt. This will increase your net wealth


3. 
   Capital to build wealth. This will increase your net wealth


4. 
   Go for training, courses, higher education. This will increase your future net wealth

You have the choice of spending it on your family, or on yourself or you could choose to delay spending to the future, and deploy your cash flow to build wealth assets now.

In order to build wealth your GAP needs to get larger and larger. Then you can put them in investments to earn a higher rate of return.

To increase your personal free cash flow or GAP:

1. Increase your income


2. Decrease your expenses


3. Optimize #1 and #2

The really smart ones will do #3.

But let me go through them with you 1 by 1 to show you the impact.

1a. Optimize Your Expenses

For most people the expenses are an easy win. They may be unsure if they could get a better salary. A much lower hurdle is trying their best not to overspend.

In fact, they should make good spending decisions.

Buy things that cost more but last for a long time, which you use very often.

For those things that are low in your priority, make peace with it. Spend less on them.

It is OK to indulge in one of your hobby. It is a financial disaster if you have many, many fleeting interests and always spends top dollar on them. They will add up.

Be a value spender. Ask yourself why you really need that something. Find an acceptable grade of the goods and services you need, and try to spend as little as possible to purchase it.

Given the same salary, same salary growth, same rate of return of their entire wealth, the expense optimizer wins out by being frugal.

For many years after I graduated from university, I kept my expenses at slightly above university level. I provided for my family and pay down debt.

Other than that, I do not spend much.

The significance is that my savings rate, is 50%. The typical savings rate for most I know were usually less than 30% more or less.

A 50% savings rate vs 10% savings rate (click to see larger table)

The table above compares an expense optimizer, with one that does not optimize.

Because she optimizes her expenses, her savings rate, which is income minus expenses divide by income is 50% versus someone who only has 10%.

The starting investment is $40,000 and the investment rate of return is 4%, her wage growth is 3%.

The net wealth built up at year 30 is $1.3 mil versus $428k. Even in year 5, the difference is almost 3 to 4 times.

Your Savings Rate is the biggest determinant of building wealth at the early stage. Notice that the difference between those who optimize and do not optimize expenses is very big even after 5 years.

1b. Earn More & Higher Income

The other side of the equation is to increase your income.

Your human capital is your greatest asset. Your human capital refers to your ability to work, or create a service or business. How much is your human capital? It is the aggregate of all your annual income in the future, adjusted by inflation, back to today.

If you are younger, your human capital would be much greater than a middle age or someone that is older.

But all this human capital is intangible. You have to convert your human capital into wealth assets by putting your personal free cash flow into assets that grow in value over time.

To grow your income, get into a field where there is demand in the future. And it is not a field where it will be obsolete soon. Always strive to improve your competency, add to your experience.

Build up deep competencies in certain areas where

1. People are willing to pay you for


2. People need it


3. what you enjoy or find it acceptable to be doing


4. what you can develop deep competency in

Eventually, you may be able to create products and service out of it and become an entrepreneur. You can create a side business out of it. Instead of getting paid for a fixed amount of hours you work, get paid for value you delivered.

A 7% income growth vs a 3% income growth (click to see larger table)

If we compare two persons with the same savings rate, starting income and wealth rate of return, the one that focus on enhancing his or her income growth will build greater wealth.

The person who focus on income growth will earn a compounded income growth rate of 7% a year versus the one who doesn’t (3% a year).

Initially the difference is not a lot. However, after 20 years, the difference start becoming apparent.

Of course, your income growth experience may be different:

1. Greater income growth when you are younger


2. Higher risk of retrenchment and stagnation when you are older

However, if you calculate the growth of salary over your working career of 30 years, it should be around that range.

My salary growth was not spectacular in the past 15 years. If I annualized my salary growth rate, my salary grew at a compounded rate of 6.6% per year.

The slight difference is that in a matter of luck, Investment Moats became sort of a side business that became income generating. So this adds on to my net wealth as well.

Learn from my experience. Do better here.

2. Build your Wealth Wisely over Time

By increasing your income and optimizing your expenses, you increase your personal free cash flow.

You consistently increased the gap.

As I have said, you have to sensibly convert your free cash flow into wealth assets. And then grow this wealth assets at a good rate of return.

Albert Einstein famously said that compound interest is the most powerful force in the universe. Einstein said, “Compound interest is the 8th wonder of the world. He who understands it, earns it; he who doesn’t, pays it.”

Create your own wealth machine that gives you recurring cash flow when you need.

The diagram above is a more detailed version. It shows how your personal endowment fund or wealth machine would look like if you create one. (what are wealth machines).

In this personal endowment fund, you are the investment manager and wealth manager all roll into one.

These are some of the sequence of investment and wealth management actions you will perform:

1. You put the personal free cash flow you build up (refer to the Cash from Disposable Income going in) into this wealth machine of yours


2. You make the important financial decisions what financial assets you want to put this cash into. Why do you put into these financial assets. When to buy more, hold on to it, and when to sell or re-balance it into another financial asset


3. These financial assets
   
   
   1. Grow their value (or crumble in value if you do not do it well) over time
   
   
   2. Pays out interest, rental, business and dividend income over time
   
   
   
   


4. 
   Keep the interest, rental, business and dividend income inside your wealth machine. Don’t spend it. Reinvest these income into more financial assets
   


5. If you repeatedly do #1 to #4 over time, your wealth machine builds up


6. The advantage is that as your wealth builds up, you can sell a proportion of your financial assets over time on a recurring basis. This creates a wealth cash flow that can pay for all or part of your expenses. Or for some emergency spending

You have to make some good financial decisions here. Because if you do not make good decisions, your wealth will shrink. The wealth cash flow will not come in. Too much wealth cash flow is paid out such that it puts stress on your wealth machine.

We will go into more of that later, but first let us see the significance of the investment rate of return of your wealth.

Why your Rate of Return Matters

A wealth builder compounding at 5% versus one that compounds at 1% (click to see larger table)

We have 2 person building wealth at 2 different rates.

Suppose person A focus on building wealth and was able to earn a 5% a year rate of return on her wealth.

Her cousin, person B, thought it is too risky to invest, and put her money in higher yielding deposits that earns 1% a year rate of return.

The result is that after year 15 onward, Person A greatly outperforms Person B’s wealth accumulated.

Here are some more ways to look at it.

Net Wealth growth at different rate of return

If we compare different rate of return, of course the higher will be better. But from what we can see, you won’t see the difference in the first 10 years. You will probably see the difference after that.

The table above shows the growth in these 4 lines in detail. 3% versus 9% at 15 years is like 40% different. So is 0% versus 6%. If you go up to 20 years it is 55-60%. 25 years is 65-75%.

Compounding takes time.

Why you may not be building wealth wisely

There is a need to emphasize on building wealth wisely.

Many of our friends do well by consistently increasing their GAP, but because they are conservative, majority of their wealth is put in savings, fixed deposits or pay down debt.

From my experience, it can be challenging earning 5% a year on your entire financial net wealth or even on your portfolio.

There are a lot of personal wealth destruction going on:

1. James boasted to you about making 100% returns
   on a few stock gains, but turns out that is just 10% of his financial net
   wealth. Overall, it is just a 10% gain. And that gain didn’t last


2. James perhaps forgot about the stocks that was
   still on his portfolio that are on unrealized losses. He does not dare to take
   a stop loss


3. Michael took up a course on forex trading. He
   thinks that this will give him the edge, prevents him from suffering from
   common mistakes amateurs make. He also thinks he learnt some certain tips of
   the trade. It turns out that trading in real life, versus simulated accounts,
   is very different. He blew up his $20,000 account in less than 3 months,
   despite the course. Luckily this is only 30% of his net wealth. The rest of his
   net wealth is in cash savings. From his financial net wealth, he is down 30%


4. Louis wanted to find a way to invest to beat
   inflation. He learns from a Facebook group to invest in a Roboadviser through
   exchange traded funds. He contributed for 1 year and there were decent gains.
   However, he felt that the returns were “too slow”. Seeing that his friend is doing
   quite well investing in real estate investment trusts (REITs), he decides to
   sell off the holdings in the roboadviser, and invest in 3 high yielding REITs.
   He just happened to invest at an all-time high. The REITs subsequently lost 25%
   in value. He got demoralized by the experience. He tells himself he will only
   invest when the stock market crash. For the next 8 years he did not invest. He
   had a demanding job and could not always pay attention to the market. There
   were times when the market was down 15% and that was an opportunity but he was
   too busy to take advantage. So he stayed in cash for this whole while. The market
   was up 59% during these 8 years

James, Michael and Louis’s experiences are not unique. They
can be rather common.

A lot of the main reasons is due to:

1. 
   Picking the Right Strategy for yourself. There are many financial instruments out there. However, for each, there are a few ways that people attempt to build wealth.
   
   
   • 
     Some are sound strategies that give you long term positive expected returns. Some are unsound. There are no clear signs they give positive expected returns in the long run
   
   
   • 
     Some strategies take up too much effort of your effort. For some strategies, you need to have your head plug into the financial markets for wealth building to be a success. Usually these are suited for full time investors doing it as their job. This might be right for wealth builders who are interested and willing to make this their second job. However, for those who are busy, it might not be the right match. Most are not willing to take this second job
   
   
   • Competency. For some strategies, the competency that you require to get long term sustainable positive expected return is low. For some is high. Most often wealth builders underestimate the competency required, and overrate their own competency level
   
   
   
   


2. Behavioral. It is important to use the right financial assets but building wealth is also very mental. A lot of people could not build wealth because they cannot overcome their mental hurdles

So what should you do?

1. Build up the financial competency to invest


2. Build up the financial competency to manage your wealth


3. Find a good financial mentor to learn from


4. Find a trusted and competent financial confidant and delegate the wealth building and stewardship of your wealth to them

I do suggest that for some who have build up their GAP #4 is very good. But to know which mentor is good, who can be trusted yet competent, you need to know what you need to know.

That requires some minimum level of financial competency. You have to compound your financial competency over time just like your wealth.

If not you will be eaten alive.

Pick the right wealth building strategy for yourself

In the image below, I listed some popular wealth building strategies.

Different Wealth Building Strategies

Some of them need higher financial competency. Some needs a lot of upfront and recurring time and effort.

I have been an active stock investor for the past 14 to 15 years. I have also started in the unit trust world. So that is where I am familiar with and how I built the majority of my wealth.

For those who wish to build wealth wisely, they can look into build wealth with a low cost, passive portfolio. Select 2 low cost funds that covers the global equity and bond market. Overtime, add the free cash flow or the difference between your income and expenses to these 2 low cost funds.

Bringing it all together: Higher Income, Lower Expenses and Compounding your Money over Time

If you strive to increase your income, optimize your
expenses and build wealth wisely, your wealth will grow in a different way
compared to your peers.

Mary went down this path. Kate took the traditional route.

Mary:

1. Savings Rate: 40%


2. Starting Income: $40,000 a year


3. Rate of return in Wealth Investments: 5% a year


4. Income growth rate: 7%

Kate

1. Savings Rate: 20%


2. Starting Income: $40,000 a year


3. Rate of return in Wealth Investments: 1% a year


4. Income growth rate: 3%

Why Mary did better than Kate (click to see larger table)

Just by growing the GAP and building wealth wisely, Mary ended up with a lot more than Kate even from year 5 onward. In 30 years, the difference is almost $2.2 mil.

You can see that if you just get the basic wealth foundation
right, your wealth will build up.

Had you not come across this and do not know this wealthy
formula, how much you will be missing.

To summarize:

To increase your GAP/Free Cash Flow:

1. Increase your income


2. Decrease your expenses


3. Optimize #1 and #2

Build Wealth Wisely

What Makes the Most Impact to Your Wealth?

John Rekenthaler, head of Morningstar research, wrote a piece on what matters the most to building wealth. In the article (which is behind a paywall) he list down the few ways a person can increase their wealth.

They are:

1. 
   Start early. Find a time machine to go back and start earlier


2. 
   Higher salary. Get a 25% raise to $50,000 a year


3. 
   Salary growth. Grow his or her salary at 4% instead of 3%


4. 
   Increase savings rate. Instead of saving 6% of the annual income, choose to save 8%


5. 
   Increase company match. The company willingly increase how much it matches the employee’s contribution rate


6. 
   Cheaper investment plan. Instead of 0.72% expense, switch to a plan similar but cost 0.22%


7. 
   Better rate of return for your investments. Get a investment that yields 8% instead of 7%


8. 
   Retire later. Wait 2 more years to retire, instead of 67.

John found that some of these make a greater impact to you when it comes to building wealth then others.

Here are the results:

You will realize a few of those that make the most impact, it is also within your control

• 1 – Early start


• 2 – Increase your savings rate


• 3 – Retire later

The rate of return (#6 Better funds) actually is rather small!

Let us look at why.

a. Start Building Wealth as Early as you can

You cannot turn back time.

So this one is more applicable to you young ones reading this.

If you can put away into investing & building wealth as early in your life, you can build more wealth. What many didn’t realize is that you can also put in less capital and get the same result.

The above example shows this.

You have three person Early, Late and Early and Continue:

1. Early started early and put in $6000 a year for 15 years then stop. He built up $613k by putting in a total of $96k


2. Late started 15 years later and put in $9000 a year and never stop. He built up $598k by putting in a total of $270k


3. Early and Continue started early and put in $6000 a year and never stop. He built up $1 million by putting in a total of $276k

Clearly putting in early helped. But if you can keep continue doing it, you will do alright as well.

b. Bump Up your Savings Rate

You can save near 80-100% of your personal free cash flow.

If you divide what you save over your income, you get your savings rate. Your savings rate includes what you put into investments.

The higher your savings rate, the faster you build wealth.

If your income is higher, you can have a greater savings rate. If your income is low, you will have to optimize your expenses. But you can only do so much optimizing.

Savings Rate Difference (click to see larger table)

If we revisit the table where we compare the savings rate, you can see the different is immediately seen at the 5 year mark.

Rate of Return Difference (click to see larger table)

In contrast, the difference when it comes to rate of return is only felt after 15 years.

Your savings rate is more important than this.

For those who are pursuing financial independence for example, your savings rate in this case may matter more than your investment rate of return.

Let us see why.

How your Savings Rate and Rate of Return Matters to your Financial Independence Goal

If you ask me why do we want to build wealth, it is so that we can buy some thing later.

But I feel that a lot of us want to be in a position so that we can choose whether we want to work or not. To do that, we need a stream of cash flow that is able to cover our current annual expenses.

If you have a portfolio of investments, or what I called a wealth machine, you will be able to do that.

We can slowly build up our investments. At first, it cannot produce much recurring annual wealth cash flow. But as we repeat the Wealthy Formula that I explained in this article, your investments will grow. So is your recurring wealth cash flow.

For others, it is less about work optional but to alleviate their financial insecurity. These financial insecurity manifested when they face financial trauma in the past (typically when young). Financially insecure people do not want to have no money for food, shelter and some basic living. They don’t crave for the world. If you are like that, you may just be looking for a stream of cash flow to cover your essential expenses and a little more of the good-to-have expenses. You are seeking out financial security.

How fast can we build up our wealth to be financially independent or secure?

How many years it will take you to be financially independent, depending on your investment rate of return and savings rate

This chart shows the relationship between your investment rate of return versus your savings rate. Observe 8 lines of different color. Each of these lines represent 8 different investment rate of return of 1%, 2%, 4%, 6%, 8%, 10%, 15% and 20%.

On the horizontal axis, we observe different savings rate (% of income channel to Wealth).

This is how it works. Suppose you make $10 from work. If you save 100% of your personal free cash flow of $6, it means that you spend 100% of the other $4. We use the standard 4% withdrawal rate to determine how much wealth you need to retire / be financial independent.

The vertical axis shows the number of years. The smaller the number of years, the faster you get to be financially independent.

Observe that when your savings rate is near 80%, all the lines bundled together. This means that no matter whether your investment rate of return is 1%, 2%, 4%, 6%, 8%, 10%, 15% and 20%, the time you will be financially independent or secure is almost the same.

As you get to a lower savings rate, say 50%, it starts to spread out. But at 50% the difference between a 1% rate of return and 20% is still within 12 years.

For most people their savings rate is below 30%. So the difference in number of years to financial independent is 14 years to 46 years.

Here is another view of the same data:

If your savings rate is high, the investment rate of return matters less. If you cannot jack up your savings rate, you got to take more risk, increase your investment rate of return.

In the illustration above, the solid line are different savings rate but 3.5% investment rate of return. The dotted lines are different savings rate but 7% investment rate of return. Observe that the dotted lines are pretty close to the solid lines.

It is another way of showing that if you want to take less risk with your money, increase the savings rate.

But it is Absolutely Necessary that You Learn to Invest and Manage Wealth Well from an Early Age in order to Stay Rich

The previous section may lead you to conclude that you should focus on earning more, optimizing your expenses, and boosting your savings rate.

That is true.

But at a certain point, your wealth will be so large that the rate of return will be more important.

I realize many might not have grasp this relationship so I explain more here:

1. Focusing on Saving More Versus Focusing on Investing: Are you Being Smart about It


2. Why You Should Not Force Yourself to Start Investing ASAP

You have to remember this.

To build wealth wisely, you got to invest and manage your wealth well. In order to do that, you need an adequate level of competency.

That level of competency cannot be acquired in a short span. Many thought they could. However, they learn the hard way by losing a lot of wealth along the way.

And it is worse when you lose your wealth when your wealth is substantial, and you have less time to make them back from your job.

Those who paced themselves by learning to invest and manage their wealth, and save well over time is able to manage their wealth well when their wealth becomes more substantial.

Those who Succeed to be Rich Do Two of These Very Well

In project management, we like to say you can only have 2 of quality, speed and cost. You cannot have all three.

What we observe is that you

1. 
   Earn a good income but remained frugal but do not have the time to learn to invest


2. Does not have a high income, am rather frugal but you have the time to learn and invest. Most of all, you can earn an above average rate of return
   


3. You are high income and know how to have a high rate of return, but you cannot have the time to budget or control your expenses

There are the rare few that is able to do all three well. But if you do only one of these well, it is likely you need to do that thing very very very well in order to get rich.

If you ask me I would rank myself as such:

1 Very frugal. Relatively less expenses than the standard family. This should be my greatest advantage out of the three

2. Slightly above average rate of return. We usually measure rate of return by either time weighted average rate of return (TWRR) or dollar-weighted average rate of return (XIRR). The first one is hard to calculate but to calculate the second one, there is a quick and dirty method.

My XIRR is about 9-10% over near 15 years including the un-deployed cash in the portfolio. If we measured against others, I do not think this is fantastic investment returns. However, if we measured against the general population, who have made many investment mistakes, or have generally been in low rate of return asset allocation, I think this gives me an edge.

3. My income from work would be average. But as Investment Moats became a side business, it does contribute a little.

For most, you would do very well with taking care of #1 and #3. But you should aim to be rather rounded in #1, #2, #3. Building wealth is not hard as long as you let the time aspect work for you.

How do You Stay Rich for a Long Time

Jaime Townsend knows a thing or two about how the wealthy stayed rich. Jaime helped steward the money of the rich at Lawton Partners Wealth Management in Canada.

Lawton specializes in helping business owners transition their businesses from one generation to another generation.

The one thing that he noticed that allows these people to continue to stay rich was that they manage to passed on the know-how and most importantly, the family values from one generation to another.

When the values are passed down successfully the wealth tends to follow.

You may be building the first generation of wealth, but you can learn a lot from what those that stayed rich in many generations.

We may be wealthy by getting rich fast. This can be due to our luck just having the right opportunity, at the right time. And we did the right thing at the same time.

However, what will make us stay rich is whether you acquire the financial competency to invest and manage your wealth over time. American investor Warren Buffett made most of his money after the age of 70. For most of us, we are considered infants versus that age.

In order to grow wealth, and compounding to work its magic, you need time.

This means that our financial competency needs to show up not just in 1 year but over many years. This cannot happen over night.

If you find your financial competency sorely lacking, make a resolve to build it up fast from today. If not, find someone that is competent, yet trusted to manage it for you.

Summary

This is a long post so let me summarize the formula, in slight detail:

1. Grow that GAP or your Free Cash Flow
   
   
   1. Earn more income
   
   
   2. Optimize your expenses
   
   
   3. Balance #1 and #2 out
   
   
   
   


2. Learn to build wealth wisely
   
   
   1. Build up your financial competency to a sufficient level
   
   
   2. Get as great of a risk adjusted rate of return as you can
   
   
   3. Reinvest your capital gains, rental, interest, dividend, business income into your wealth machine
   
   
   
   


3. Learn what makes the most impact to building wealth
   
   
   1. Start investing early
   
   
   2. Boost your savings rate to as high as you can
   
   
   
   


4. Learn to at least do 2 of these stuff well

I cannot promise you that you will be very very rich but this is the most generic, yet realistic way to achieve it.

If you want to get rich quick: Grow that GAP very very fast by getting into sales. That will earn you a lot. Watch your expenses well. Then at the same time, be really fortuitous to be able to build wealth at a greater than 20% a year rate of return.

For those that could not, I hope that this post serve as a guide to show you how to realistic become wealthy over time in your own way.

DoLike MeonFacebook. I share some tidbits that is not on the blog post there often. You can also choose to subscribe to my content viaemail below.

I break down my resources according to these topics:

1. 
   Building Your Wealth Foundation– If you know and apply these simple financial concepts, your long term wealth should be pretty well managed. Find out what they are


2. 
   Active Investing– For the active stock investors. My deeper thoughts from my stock investing experience


3. 
   Learning about REITs– My Free “Course” on REIT Investing for Beginners and Seasoned Investors


4. Dividend Stock Tracker – Track all the common 4-10% yielding dividend stocks in SG


5. Free Stock Portfolio Tracking Google Sheets that many love


6. 
   Retirement Planning, Financial Independence and Spending down money– My deep dive into how much you need to achieve these, and the different ways you can be financially free


7. 
   Providend – Where I work doing research. Fee-Only Advisory. No Commissions. Financial Independence Advisers and Retirement Specialists. No charge for first meeting to understand how it works

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