Retirement planning to get tougher

BlackRock Inc’s global chief investment strategist Richard Turnill said in a Bloomberg report in late July that it is going to be really hard for any asset class to give investors returns of more than 6% in the coming years. 

“Most won’t even scrape 5%. Our five-year return assumptions have steadily moved lower since the financial crisis, amid weak global growth prospects, easy monetary policy and rising valuations. We have lowered our assumed returns for most fixed-income assets, following a drop in yields (and rise in valuations) in the second quarter,” he added.

According to Schroders’ Seven-Year Asset Class Forecast Returns: 2016 Update, Asia-Pacific ex-Japan equities will generally be the best performer in the 2016  to 2023 period, with real returns forecast at 8.5%. This is followed closely by Japanese equities, with real returns of 7.9%. UK equities will be the worst performer, delivering real returns of -2.1%. Private equities will do well and is predicted to generate a 7.5% real return (see table).

The low-growth, low-return environment will make it much tougher for those heading for retirement. In McKinsey Global Institute’s Diminishing Returns: Why Investors May Need to Lower Their Expectations, released in May, it was found that lower rates of return could have a profound effect on both individual and institutional investors, and by extension, on governments as well. For example, a 2% difference in average annual returns over an extended period means that a 30-year-old today would have to work seven years longer or almost double her savings to live as well in retirement. 

“As a result, pension funds could face a funding gap that is even larger than the one they are struggling with today. Among others likely to be affected are asset managers, whose fees will come under pressure in a lengthy period of lower returns, and insurers that rely on investment income for earnings … policymakers may need to prepare for a later generation of retirees with less income,” says the report.

As it is, one’s retirement savings are usually not enough. In May, EPF’s head of strategy management Balqais Yusoff pointed out more than two-thirds of its contributors (78%) did not have at least RM196,800 to sustain them in their retirement years.

As pensions are going to be affected, those who are preparing for retirement today have to make serious adjustments to their lifestyle or savings, says Wan Kamaruzaman. “We are trying to educate civil servants on the importance of financial planning when they enter the labour market. Financial planning starts the moment you start working. 

“Previously, we focused more on people nearer the retirement age. But now, it is the other way around. We are trying to inculcate a saving culture to remind us that we need to save more to retire.”

He acknowledges that it is not going to be easy. “It is a Catch 22 situation — you tell people they have to save more, but the cost of living and discretionary spending mean they do not have enough to save. Companies are not performing that well, so obviously, the bonuses will not be as great. It is a vicious cycle.” 

Datuk Javern Lim, group managing director of VKA Wealth Planners Sdn Bhd, advises people to focus on increasing their monthly income so as to be able to save more. “Focus on increasing your monthly income stream, which can lead you to save a bigger 10% portion for investment too. Consider some structured investment products that may require a longer lock-in period but are able to offer a higher return on investment.”

In an investing climate like this, investors may be tempted to invest in higher risk assets to compensate for the lower returns from other assets. But Yong Chu Eu, licensed financial adviser at Fin Freedom Sdn Bhd, advises against it. He does not recommend taking higher risks in today’s climate as investors risk losing all of their money.

“High living costs are pushing more people to more complex, short-term, high-return investment schemes so that they can have their retirement on track or financial freedom soon, which I don’t think is appropriate. Because of this, many people end up losing money after falling into investment traps or scams, or taking on too high a risk,” he says.

Lim advises investors to stay away from investments that could see them lose all of their money. “When we invest in unit trusts, we invest in businesses. When we invest in properties, in the worst-case scenario, the properties are still there. The same goes for gold; the gold bars are still there. We are talking about accumulating a retirement fund for our old age. Our retirement fund is serious money. We cannot afford to lose it,” he says.

Picking an investment that offers tax benefits is all the more important in this climate. Lim says investors should consider instruments that could offer moderate returns and yet free you from tax implications. PRS is a case in point.

“[If you are in a high tax bracket,] you have already saved 25% in tax on that RM3,000 invested, that is, assuming the RM3,000 did not give you any returns. Moreover, the PRS funds are managed by the fund managers who also manage the existing funds [into which many of the PRS funds feed]. 

“Under the regulations, they can only charge up to 3%, so there is an immediate saving of 2%. Some even charge a 0% fee.”

De Alwis advises investors to reexamine their portfolio. “If everybody is chasing returns, now is the time to look again at your portfolio to ensure that you really have diversification across the different investment classes. Bear in mind, I don’t mean asset classes, but investment classes,” he says.

“When I say asset classes, many get confused because they begin thinking how much they should put into equity, fixed income and balanced funds. When I say investment classes, it is a good time for you to look again at things on a holistic level — how much exposure you have in unit trusts, the stock market, properties, bonds and so on.”

Today, it is even more important for investors to set a “true blue minimum target”, he says. “When I ask investors, they tend to say 8% or 10%. But your true blue minimum target should be your real inflation rate, which should be averaged at 3% to 4%. 

“You can be more ambitious and give yourself 5%. But first things first. You have to build a portfolio to make sure you can achieve that minimum 5%. From there, you need to remember that you have certain things that give you higher returns over a certain period. 

“You have to look at the annual returns of your portfolio. Start looking at those that give you higher returns over a rolling period [when returns and markets] are higher, and those during years that are lower.”

Investors must revisit their retirement portfolio and set realistic targets. De Alwis says with a floor target, their mindsets change and they find that they do not need to take on much risk to achieve their targets. 

“If I were your financial adviser, I cannot build your portfolio around 8% [which is your ideal target]. I need to set a minimum floor of 5%. After that, we ask how do you achieve more than 5%? 

“Let’s say you want 8%. If you use the rule of 72, you will need nine years [to double your initial investment]. But if you take 72 and divide by 5%, it will take about 12 years. Is that acceptable or do you need to put more money in? Do you need to save more? Then the reality sets in. 

“So, I always ask people to take a few steps back. I am not saying you should put everything into less risky assets. But once you take a few steps back, you would have better peace of mind. I have already conservatively decided that I need 5% and I have 12 years to [double my investments], so that means I will be fine. 

“It is a fact that the low-yield environment is here to stay. So, manage your expectations and revisit your portfolio; whatever extra is a bonus. Be more pragmatic about your financial planning — diversify properly across all investment classes.” 

Investors must always have cash ready to deploy to take advantage of future opportunities and to average down. “These two strategies are different because averaging down means doing it when the market is down. You do not want to be forced to realise your loss. Opportunity means when you see a potentially good investment coming and you don’t want to sell down [your other investments], you have the cash. Now is a good time to revisit your portfolio because there are always opportunities when the market is down. 

De Alwis elaborates further on portfolio allocation. “In your portfolio, 20% should be as liquid as possible because the first rule of thumb of liquidity when you invest is you need to know how much your reserve can last you. 

“Before you invest in anything, make sure you have a cash reserve of three to six months. That is the basic principle. Once you have the reserve, you can invest the additional portion. Of that portion, I recommend putting 20% in liquid assets. 

“You never know when an investment opportunity is coming and you want to catch the trend without have to sell any of your current holdings as it is just a short opportunity that you can liquiditate later. Do not have an investment portfolio that gives you no choice but to realise your losses unnecessarily.” 

Options for EPF contributors

Contributors to the Employees Provident Fund (EPF) have a few options if the dividend is low. Yong Chu Eu, a licensed financial adviser at Fin Freedom Sdn Bhd, says they can use their EPF savings to pare down debts such as their mortgages or withdraw more to put into unit trusts.

“They can use their EPF savings to offset debts, especially housing loans. If interest rates fall to a similar rate as the housing loan, the free cash can be used to invest.

“Let’s say your current effective interest rate for the housing loan is about 4.5%. If EPF dividends fall below 5%, then it is wise to withdraw your EPF money to pay monthly loan instalments for a year, which will give you free cash to invest. This way, you are managing your ‘good debt’ to grow your wealth.

“They can also withdraw some of the EPF money [quarterly] to invest in approved unit trusts to get more returns. The EPF investment strategy is very conservative. If you look at its previous annual reports, most of its money are invested in bonds and the guaranteed annual return is 2.5% (the average return over the past 64 years has been about 5.9%). 

“That might not match the risk appetite of someone who is hungry for higher returns or looking for more risk (more equity/foreign exposure) ... If we refer to Fundsupermart’s fund ranking (last updated Aug 20), Kenanga Growth Fund is the top performer with an average 17.2% return yearly for the past 10 years (about around 17% annualised return for the past 15 years). This fund’s returns are far more superior than those of EPF and unit trusts.”

Those who have cash to spare can place their savings in private mandates under the EPF-approved investment scheme. A quick check found that PhillipCapital is a provider of the private mandate option. 

“Investors can withdraw their money from Account 1 and pass it to the EPF-approved fund managers who will select stocks for them. The minimum investment is RM30,000, so this option is only for investors who are willing to take higher risks in exchange for possibly higher returns,” says Datuk Javern Lim, group managing director of VKA Wealth Planners Sdn Bhd.

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