Hey you. Yes, you. The young fella standing there and smiling smugly. You are doing great. And generating a steady source of income, diligently following the Warren Buffett mantra to “not save what is left after spending but spend what is left after saving”. You have been saving 15% of your salary consistently each month. Nice work. Yet, why is it that you remain far from reaching your desired life goals? Is this the time for a bit of soul-searching? You are hitting the big 3-0 this year, after all!
What’s gone wrong? Truth is, savings alone is not good enough. Making your money work harder is more fundamental.
It is the global financial crisis. You are afraid of losing your job. The stock market is crashing. You are afraid to invest. You don’t know if it is the “right time”. Just like everybody else, you are waiting for the market to hit rock bottom before investing. While waiting for the next dip (which, by the way, is not happening from where I am standing now), you missed out on the biggest opportunity by not staying invested. The market has since rallied.
You left most of your savings rolling in fixed deposit accounts, earning an average interest of 3% per annum over the past 10 years, which you thought represented good, steady returns.
The next thing is to understand the power of compounding. Sure, hindsight is a great teacher. But stay with me, will you?
By keeping RM50,000 in a fixed deposit account that returns an average of 3% every year, you gained RM67,195 in 10 years. Well done. But had you invested that RM50,000 in a balanced investment portfolio that returned 6% every year, your cash would have grown to RM89,542 in 10 years.
To put it simply, you would have earned RM22,347 more if you had invested your cash in an investment portfolio instead of keeping it in fixed deposits for 10 years. Over the long term, investing your money is a better option for exponential growth through the power of compounding. This is more so now with Bank Negara Malaysia slashing the Overnight Policy Rate to a historic low, and fixed deposits generating a meagre 2% interest per annum.
From my vantage point today — sure, you did not have it then — I can see that the US Federal Reserve has shifted its strategy to seek an average 2% inflation over time. That means we will see the central bank keeping the interest rate close to zero for the next three to five years, before even thinking about rate hikes. Similarly, in Malaysia, interest rates will continue to stay low for the next few years and, with an average 2% inflation rate, we are not making our money work any harder.
Worried about losing your job? First things first. Set aside emergency funds of at least six months, or up to 12 months of your last drawn salary, in your savings account. Why a savings account, you may ask. Emergency funds, as we call it, are for your emergency use; they must be liquid. Having emergency funds tied up in a fixed deposit, typically with a one-year tenure, will not yield any returns should you need to withdraw them before the maturity date.
Banks today have more innovative savings accounts that can boost interest rates to as high as a fixed deposit rate, while giving you the flexibility to withdraw at any time with no penalty. Only after you have accounted for sufficient emergency funds should you invest the remaining portion of your hard-earned savings to build a stream of passive income for your life goals.
A disciplined investment plan yields higher returns. Timing the market makes you feel smart, just like getting that best deal during the 11.11 sales at midnight. But historically for most investors, it just does not work. You should employ a strict regular investment plan to plough a fixed amount of funds on a regular basis into the stock market through a dollar-cost-averaging approach. This way, you get to purchase more units when prices are low and fewer units when prices are high. Buying gradually into equities might be a more prudent way to engage opportunities in the market as the economy recovers and the earnings outlook improves. Instead of investing RM50,000 in one lump sum, you should now split your investment into RM5,000 per month for 10 months. Parking funds in safe assets and deploying them gradually into the stock market allows you to mitigate downside risks amid heightened volatility.
Every market correction presents a good opportunity to add in quality names at a discounted price. If you already have sufficient exposure to growth stocks, it would be prudent to gradually rebalance portfolio positions in tech equities into cyclicals and value, which will further diversify exposure across a wider range of drivers of performance.
Having sleepless nights worrying that your investments might suffer a loss means you are probably taking on too much risk in your portfolio. In this case, diversify a portion of funds into principal protected instruments, where you will not lose more than you put in. Consider having a savings plan that gives guaranteed cash payouts yearly, which you can choose to accumulate over the years, compounding it to give a higher maturity value. You should plan it such that the maturity of the plan suits your life goals’ timing; for instance, funding your daughter’s higher education in 13 years’ time. It is comforting to receive a lump sum by year 13 while potentially reaping higher returns than fixed deposits in a low interest rate environment.
I only wish I could have written this note to you earlier, for our benefit. Yet, 10 years on, one can be optimistic that it is not too late to start deploying that cash a lot more optimally.
Michael Lai is executive director of wealth advisory (wealth management) at OCBC Bank (M) Bhd