Den of The Lion Investor

Today, I will be sharing a case study of how I restructured my own endowment plan recently. You might want to do a similar review of your own plan and see how you can improve it.

My case study is based on a 20-year endowment plan (sum assured $20k) that I bought many years ago. For this plan, I had to pay $155.20/month for a period of 20 years and it will provide me with a coupon payout of $2000 every two years. These coupons could be reinvested with the insurer to earn attractive interest rates. There will also be a bonus that will be paid out upon the maturity of the plan.

At the point of purchase, the benefits illustration showed that I could expect to receive about $52902 upon maturity of the plan. This was based on the par fund achieving an investment returns of 6+%p.a. (estimated) and a 5.25%p.a. interest given on coupons reinvested with the insurer.

Based on my monthly premiums of $155.20, this gives an internal rate of return (IRR) of about 3.37%. If I had made my premiums annually ($1822.20) instead of monthly, the IRR would have been higher at 3.43%.

The plan also came with a couple of riders - critical illness (CI) protection and total and permanent disability (TPD). If I had done away with those, the annual premiums would have been lower at $1731. Based on this amount of premiums, the IRR will be even higher at 3.88%.

I then went on to calculate the IRR using the most recent projections given by the insurer. Obviously, it is lower. We are given projections from 3.7% to 5.7% for the par fund with the interest rate of the reinvested coupons ranging from 2.25% to 4.25%.

All the IRR results are shown in yellow in the table below. For my mode of payment (monthly with riders), my expected IRR would range from 1.58% to 2.85%.

The “Maturity Payout” in the last row shows the amount of money I would expect to receive (at different projection of par fund returns) if I reinvest all my coupons.

The last column is the original projection based on a par fund returns of 6+%.

To be honest, at the time I bought the policy, I know nothing much about investments. The plan was more for savings and the absolute numbers looked good then. Looking at the IRR now, they look a bit on the low side.

These are the things I went on to implement with the rationale given:

1. Change the monthly premiums to annual premiums. I save 2.2% every year and this beats the returns I’m getting from the banks.
2. Remove all the riders. The reason why I can do so is because I have other insurance plans that already provide sufficient cover for critical illnesses and TPD. It makes no sense to pay 5% more premiums per year for something I don’t really need (20k cover for CI and TPD). Furthermore, the purpose of this plan is primary for savings and not for insurance. Paying 5% more for an instrument that gives an IRR of 2-3% is a big deal.
3. Withdraw all my coupons that had been reinvested with the insurer. The current interest rate for the coupons is 3.25% p.a. and I am confident of beating this benchmark if I reinvest the money myself.

There you have it.

One thing I realised is that the circumstances of people change throughout the years. What is applicable in the past might not be applicable today.

Therefore, it might be worthwhile for you to go through and do a similar review of your current investment and insurance portfolio from time to time.

Being proactive about such matters can very well determine whether you achieve your own retirement goals as planned.

Click here to leave a comment.

Last week, investors with OilPods would have received a letter from the CEO of OilPods, Mr Mark Chang.

Oilpods markets (oil and gas) working interest in the US, with the oil and gas lease operated by Powder River Petroleum International, formerly known as Powder River Basin Gas Corp and traded on the OTC Bulletin Board.

Investors of those working interest receive monthly payouts based on their share of the revenue generated from the sale of the oil and gas produced.

This month, no payout was received.

A check on filings by Powder River to SEC shows that the company is having cash flow difficulties.

OilPods has instructed their legal representatives in the United States to take the necessary actions to protect the interest of investors.

All seems well on the website of Powder River Gas Corporation. They even appointed a new operations manager a few days ago.

Click here to leave a comment.

Societe Generale Asset Management will be launching a new fund this month - the SGAM AsiaPAC Income Plus Fund.

This fund invests in the Asia Pacific developed markets, namely - Singapore, Japan, Hong Kong, Taiwan, Australia and Korea.

Stock selection will be based on dividend yield, valuation and momentum. There will also be a liquidity criteria of market capitalisation over US$2 billion and a daily volume of minimum US$20 million. A final selection of 40 stocks will be purchased. This means that each stock will constitute 2.5% of the fund’s holdings.

Depending on the market conditions, the fund will apply either a “long only” or “covered call” strategy. A cover call means underwriting call options on the underlying assets. The premiums collected will enhance the returns of the fund.

As the name implies, there will be a regular payout of cash to unitholders of this fund. The payout is a guaranteed 8% p.a. coupon based on the fund’s NAV on the anniversary date. This payout will be done quarterly.

For example, the fund has a starting NAV of $1. So for the first year, $0.02 will be paid every quarter.

For the next year, the NAV at the anniversary date will be used to determine the coupon payout. If the NAV is $1.10, $0.022 will be paid out every quarter. Conversely, if the NAV is $0.90, each payout will be $0.018. And so on for subsequent years.

Do not be mistaken that the SGAM AsiaPAC Income Plus fund can give you a guaranteed yield of 8% p.a.

Whenever unit trusts are concerned, any dividend payout is always taken from the NAV.

For example, if a fund has a NAV of $1.20 and pays out a dividend of $0.05, you collect $0.05 and the fund NAV will drop to $1.15. In terms of how much the asset is worth to you, it is pretty much the same whether the dividend is paid out or not. Add in the costs incurred for paying out the dividends and you might actually be worse off.

What is more important is how much the fund can grow on an annual basis. If it can grow more than 8%, you can collect the dividend and still enjoy capital growth of the fund. If it is less than 8%, part of the 8% you collect will simply be a return of some of your capital.

The underlying assets of this fund has an estimated yield of about 4%. Thus, there will need to be a capital growth of at least 4% for your coupons to not come from your capital.

As for the management fee, it is 1.75% p.a. (max 2.0%) for this fund.

A dividend paying fund might be suitable for someone who relies on dividend payouts for living expenses. Even then, that person can simply redeem units for cash even if the fund he invests in does not pay any dividends.

For someone who wants to stay fully invested in the markets, he or she will have an unwelcome problem of reinvesting the dividends. This also means incurring extra costs again. Update: This reinvestment problem might not exist if automatic reinvestment of dividends at no cost is available. 

If you trade options but do not know what the “Greeks” are, you are playing a game without knowing the complete rules.

And if you trade warrants listed on SGX but do not know that they are a form of options, then it is far worse. You do not even know what game you are playing.

In options trading, there are four greek terms that you need to understand:

• Delta - Tells you how much a change in the underlying will affect the price of the option
• Gamma - The rate of change of delta
• Theta - Measures the amount of money that the option will lose with each passing day
• Vega - Measures the sensitivity of the price of the option to changes in volatility

The terms confused me initially too, and it took me some time of researching before I could find a good explanation for them.

Be warned - they are pretty heavy stuff and it will probably take you some time before you can reach a stage of unconcious competence with regards to understanding and using the greek terms.

Rather than reinventing the wheel and trying to explain them here, I’ll direct you to a couple of good articles on this topic.

This first article helps you to understand the meaning of the greek terms:

Getting to know the Greeks

This second article helps you to understand the relationship between them. The table in the article paints a very good picture:

Using the Greeks to Understand Options

If you go through the exercise of understanding the greeks, you will realise how important these terms can affect your options trading strategy.

On most advanced platforms, you can actually have access to these values when you are trading options.

Unfortunately, for warrants listed on SGX, you do not really know what they are. This is a severe handicap but if you can at least understand how they work, it will give you a slight edge over the rest of the playing field.

We might have come across this phrase “Rising prices is the cause of inflation“.

Is this really true? In the world of finance, cause and effect is often misunderstood.

I’m no economist - but I will try to explain in layman terms what inflation is.

First of all, the phrase I quoted at the start of this post is of course completely false.

Rising prices is the result of inflation, and not the cause of inflation. So what exactly causes rising inflation?

The money supply or the quantity of money in circulation.

There are a few ways that a government can fund its expenses:

• Taxation
• Borrowing from people
• Borrowing from banks
• Printing more money

There is no increase in the supply of money for the first two ways, but there is for the other two. Credit extended by the banks also increase the amount of money in circulation.

If a certain amount of money is printed but the population saves up the same amount of money, the quantity of money in circulation does not really increase.

However when people realise that their purchasing power is reducing, they are more likely to spend today than to put off their purchases for the future. With the addition of the printed money, this means the money supply has been increased.

An unavoidable consequence of increasing the money supply is that prices for everything will rise. Of course, asset values and wages will also rise proportionally.

Most (if not all) governments adopt a pro-inflation policy as it is easier to fund their expenses by increasing the supply of money than to raise taxes. For Singapore, the money in circulation increased from $8.1 billion in 1991 to $17.6 billion in 2006 ( click here to view the numbers from MAS).

Furthermore, inflation has a feel-good effect on the population.

Don’t you feel wealthy when the HDB you bought 30 years ago at only $20k is now worth $600k? Or that your salary has increased from $100/month to $3000/month now?

The truth of the matter is that nothing has really changed for you. A bowl of noodles that used to cost $0.10 might cost $3 now. Your salary can still buy you 1000 bowls of noodles, both today and 30 years ago.
On the other hand, if you had left your $10k under your pillow, it will be worth considerably less today.

Ultimately, money is just a form of storage for value and the effects of inflation can eat away at the value of your money.

Inflation as a whole is bad for all creditors. As prices rise, the purchasing power of the principal and interest payments will be worth less. Less goods can be bought than at the start of the loan. Unfortunately, creditors does not refer to only the banks. Everyone who has a claim to any deferred payments is a creditor.

Your savings, your CPF funds, your insurance policies, your pension - all these make you a creditor.

The debtor on the other hand can profit from inflation. The purchasing power of his loan gets smaller with time. If inflation is higher than his loan interest rates, he benefits from inflation.

An interesting thing to note about the rises in prices is that not all prices and wages increase at the same time. Companies who can increase the prices of the things they sell while the prices of the goods they buy has not risen can profit from inflation. These business thrive in an inflationary environment.

On the other hand, there are business who cannot raise their prices fast enough to offset the increasing prices of the things they buy.

The middle class as a whole generally lose out as their salaries go up slowly compared to the rise in their cost of living. The pack of rice that used to cost me $5.80 a few months ago has now doubled in price.

In Singapore, the lower income contract worker have it even worse. The newspapers reported yesterday that their wages have in fact decreased compared to what they were being paid ten years ago.

Times are very challenging for all of us - each in his or her own way.

Personally, I find it frustrating that the returns on my investments has to first overcome the high inflation rate before it even goes into any real capital growth. Failing which my wealth will get smaller and smaller.