Den of The Lion Investor

Last Sunday, I saw an advertisement in the Sunday Times by the CPF board. Inside this CPF advertisement, the CPF board tells us that we can earn more interest by transferring funds from our Ordinary Account (OA) to the Special Account (SA).

It was mentioned that the SA earns an interest rate that is 1.5% higher than the OA.

Before you decide to do that, do bear in mind the following points:

1. The transfer is irreversible, so you won’t be able to tap the funds for housing and other purposes in the future.
2. Monies in the SA have limited investment options compared to those in the OA. Only selected unit trusts are available and you can’t invest in shares.
3. The OA is pegged to a weighted average of savings deposit and 1 year fixed deposit rates, subject to the CPF guaranteed floor rate of 2.5%..
4. In the past, the rate of SA is pegged to OA+1.5%. Now, the SA rate is pegged to the 12-month average yield of the 10-year Singapore Government Security (10YSGS) plus 1%. The average yield of the 10YSGS over one year, from 1 June 2007 to 31 May 2008, plus 1% works out to be 3.65%.
5. The Government will maintain the 4% floor rate for two years (from 1 Jan 08) if the 10YSGS yield plus 1% is below 4%. After two years, the 2.5% floor rate will apply.

What this means is that it is possible for SA to give less than 4% p.a. interest. Here’s the historical yield for the 10YSGS:

• 1998 - 4.48%
• 1999 - 4.56%
• 2000 - 4.09%
• 2001 - 3.97%
• 2002 - 2.55%
• 2003 - 3.75%
• 2004 - 2.58%
• 2005 - 3.21%
• 2006 - 3.05%
• 2007 - 2.68%
• 2008 - 3.17%

Based on the rates, you would have received 3.55%, 3.58% and 3.68% interest in years 2002, 2004 and 2007 respectively. That is just 1% higher than the 2.5% you would have earned in the OA.

Personally, if I have excess funds in the OA and I am many years from retirement, I would rather invest it than move it to the SA since there is a good chance the investment will return more than 3-5%.

On the other hand, a person who is very close to 55 and has excess funds in his or her OA (that he or she doesn’t intend to use) can consider the transfer option for a portion of the funds.

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I have to apologise for the lack of regular updates in my site recently. I have been trying to get my “engine” started ever since I came back from Australia and my recent illness has done nothing to help the situation. I have also been having more hours of sleep these few days compared to the past.

If you know of any method to “kick my butt“, please do so.

On a more serious note, coming up with interesting and relevant things to write about can sometimes be a challenge. If you have any ideas on what you like me to write about, I would welcome your suggestions.

Today’s topic will be of particular interest to anyone starting out with investing but with limited capital.

Some of us might be fixated with the returns we can achieve on their investments. We spend time comparing the returns we can get on the particular class of investments we are interested in. For example:

• When placing a fixed deposit, we compare the rates at all the banks and choose the one with the highest interest.
• When buying a unit trust, we look at the historical performance.
• When buying a dividend stock, we look at the current (and projected) yields.

Certainly, such comparisons are a good practice and should be done to maximise the returns you get on your investments.

However, what most people don’t realise that there are two components to accumulating wealth: Investing your savings AND managing your expenses.

The latter is often neglected.

When I talk about managing your expenses, I’m not talking about big ticket expenditures of a few thousand dollars and above. I’m refering more to your everyday expenses.

Suppose you manage to save $50/month as a result of being more conscious about the things you spend on. $1.67/day might seem like a small amount but it works out to a $600 savings per year. Again, $600 might not seem a huge amount but let’s try to see things in another perspective:

• If you have a savings account earning 0.1% p.a, you need $600,000 to earn $600 in interest.
• If you have a fixed deposit earning 1% p.a, you need $60,000 to earn $600 in interest.
• If you have stocks making 10% p.a, you need $6000 to make $600.

If you can put aside $1.67/day for savings, it is like creating a $60,000 virtual fixed deposit investment. It might take you a long time to accumulate $60,000 but the same effects can be duplicated by the simple act of setting aside $1.67 a day. This is something that everyone of us can achieve.

What if you can save $500/month? That will be the equivalent of having a $600,000 fixed deposit working for you.

Wealth accumulation is the fastest when you can get a good return on investments and at the same time increasing your investment capital as much as you can.

This concept is even more important if you have a limited investment capital. Let’s say you only have $10,000 as investment capital.

Person A gets a 4% return of $400 by buying a long term bond.

Person B gets a 10% return of $1000 by investing in stocks.

To get the 10% return, person B might need to do a lot more work than person A. Yet the absolute return in the first year is only $600. If person A can afford to spend $50 less a month and put it into his investment fund, he would be in the same financial position as person B after one year.

A $2400 ($200/month) savings adds 24% to the $10,000 investment portfolio.

A $3600 ($300/month) savings adds 36% to the $10,000 investment portfolio.

A $6000 ($500/month) savings adds 60% to the $10,000 investment portfolio.

When the investment capital is small, the amount of money you can add on to your portfolio will play a greater role in the growth of the portfolio than the investment returns you achieve.

For a person who has just started working and is planning for his retirement, managing his expenses is a critical aspect not to be ignored. Spending on a big ticket item (like a car) will slow down significantly the growth of his investment portfolio.

Having said that, I’m not advocating saving every single penny you have. Life is about having the correct balance and everyone will have different needs depending on his circumstances.

Live the lifestyle you want, but make sure that it is within your financial means and you are able to still achieve your long term financial goals.

“If you fail to plan, you plan to fail.”

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Question for Lion Investor

Hi,

I like your blog. There is always a write up of the latest events happening in Singapore. As a Singaporean, it is very useful to be updated on all current issues. It provides a one-stop info centre.

Just wanted to check with you: about the current min. CPF sum requirement :
1) assuming I have less than the required min. cpf amt. at age 55
2) I sell my house at age 56 yrs.
3) Will the cpf auto deduct the min. cpf amt. from the sale proceeds?

Assuming:
1) I reach 55 yrs in 5 yrs time.
2) I used $250,000 CPF money to pay for my house, besides the cash portion. The house has been fully paid up.
3) I can sell the house at 1 million dollars.
4) I have $50,000 in OA, $40,000 in Special, $34,000 in medisave.

Appreciate your help on this so that I can plan when to sell my house.

Many thanks!

Elly

My Comments:

Hi Elly, assuming you continue to earn interest from the CPF board (at 2.5/4) and there are no further additions or withdrawals to your CPF accounts, you will have about a total of 144k in OA, SA and Medisave in 5 years time.

About 34k will be set aside in your Medisave as the Medisave Minimum Sum, with the balance 110k in your retirement account (RA).

The CPF minimum sum then will be about 120k, and you can pledge your property for half of this amount. This means you will withdraw 50k cash, keeping 60k cash in your RA. Your pledged property will make up for the other 60k of the CPF minimum sum.

If you sell your house at 56, 60k will need to be returned to the RA to make up for the property pledge. The amount to be refunded will increase due to the accumulated monthly interest on the pledged amount.

If you sell your house before you turn 55, you will need to refund 250k plus accrued interest to CPF. Then when you turn 55, 120k from your OA and SA will need to be set aside for your CPF minimum sum.

Since you will quite easily meet the CPF minimum sum requirement either way, getting a good price on your property might be a more important consideration for you in deciding when is the best time to sell it.

Hope this makes it clear for you.

The term churning refers to the excessive buying and selling of securities by your stock broker to generate commissions. It can also mean the excessive purchase and sale of unit trusts by your financial advisor for the same purpose.

Yet another kind is the “cashing out” of investment linked policies (ILPs) to lock in profits and then buying a new one with another fund (incurring sales charge). The same effect can be achieved with just a free switch.

As most (if not all) stock brokers are compensated based on commissions, they could have an inherent biasedness towards the client having more activity. If the client relies heavily on the recommendation of the stock broker or financial advisor but the latter has a less than honorable intention, it can be very detrimental to the health of the client’s portfolio.

The other day, I bumped into a ex-colleague (let’s call him Z) who wanted to liquidate his entire portfolio of unit trusts. His CPF investments of 80k+ had suffered a drop of more than twenty percent. His wife’s portfolio had suffered a similar fate and they were both advised by the same financial advisor.

I asked to take a look at his past transactions and this is what I saw.

• Z’s funds were invested in only the China and India market since last year.
• In March this year, he requested to switch all his funds to bond funds as a safe haven from the falling equity market. For this he was charged a 3% sales charge.
• In May, his so-called advisor “advised” him to switch his holdings back to equity to take advantage of the market rebound. All his holdings were switched back into two funds, one China and oneIndia fund. He was charged another 3% sales charge.
• As a result of the switch done in May, his portfolio suffered a further drop of 10k+.

I did not know whether to be angry or sad with what I saw. The CPF savings were Z’s lifelong savings.

There are two issues here. Incompetency and a lack of integrity.

Incompetency because

• No advisor in his right mind would tell his client to invest all his funds into only two regional equity funds.
• Trying to market time the rebound is a foolish thing to do.

Lack of integrity bacause

• The switching occured so soon after the initial sale with obvious tell tale signs of churning. If the advisor had wanted to actively manage the client’s portfolio, the funds should have been placed in a wrap account whereby fund switching is free. The client only needs to pay an annual warp account fee (typically 1%). If you do the maths, you will find that just one switch in three years will more or less make up for the wrap fees.
• According to Z, some (a couple of dozen) of his friend’s were in the same ship as him and have suffered heavy losses as a result of being served by that particular advisor. So, this is not just an isolated case.

Financially, the advisor is doing very well with all the commissions he has generated. Perhaps he is even given incentives for his performance. What an irony.

The sad thing is that the problem of churning in the industry goes even further than this.

Have you ever seen advertisements in the newspapers offering cash loans? One of the methods they employ is that they use your CPF monies to purchase unit trusts, charge you a sales fee of 3% and rebate you with some of the money.

Many cash straped people have no choice but to take up the offer. They can’t touch their CPF money and they would rather have cash on hand to meet their needs.

The goverment has taken certain measures that helps to reduce churning. One is the imposing of a 3% sales charge cap for funds purchased using unit trusts. Another is to disallow completely the use of the first 20k in our CPF OA and SA for investments.

While these measures might help to reduce churning, unfortunately, it can never be eradicated.

When the market goes on a bull run, many people don’t really scruntinise their transactions as they are making money.

The individual would do well to take a personal interest in his own investments and check how his portfolio is being managed, be it bull or bear.

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The other day, a contractor from City Gas came down to my house to do a site inspection. I had requested for him to check whether it was feasible to install the City Gas water heater and clothes dryer in my home.

The reason why I did so was that I was attracted to a recent promotion that City Gas was running. They were offering a package of the City Gas Water Heater and Dryer at $688 or the Heater at only $168.

According to the illustrations given, using a City Gas Heater in place of an electric one will cut the energy cost from about $30 to $10. This is a significant reduction.

Using a City Gas Dryer will reduce the cost from $5.73 to $3.88. This works out to be about 30+% reduction.

Unfortunately, the contractor deemed my house to be unsuitable for doing the installation. Thus, I was unable to proceed.

With energy costs increasing, people will become more conscious of such savings and there might be more people switching to the use of City Gas products.

The beneficiary of this would be course be City Spring, a listed infrastruture trust that is pretty much a dividend play. The current price of $0.775 offers a yield of about 8.3% p.a. The lowest price ever reached was about $0.70.

Of course, investors should remember to bear in mind the (ridiculous) performance fee structure, which is based upon the share price.

As a result of a spike in the share price in the past, the managers collected a huge performance fee. I can’t remember how much it was but I remembered it was a huge chunck of reported earnings.

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