Timothy, a successful businessman, plans to retire soon. He has set aside RM3mil to finance his lifestyle after he quits his business. By Tim’s reckoning, he can live comfortably off the interest that he will earn from putting that sum in fixed deposit (FD). Assuming that the bank pays him 4% per annum on that amount, he expects to live off the RM120,000 in interest.
Sadly, Tim has made a serious miscalculation. He has forgotten to consider the extent to which inflation will erode his savings. This mistake alone can potentially throw all his plans for his golden retirement out of the window.
What Tim, like most people, is using the conventional way to fund their retirement.This can be referred to as the one-step approach. We put our money in FD in order to earn interest, draw on our Employees Provident Fund dividend, invest in property to earn rental, buy bonds to get the coupon and so on. The income generated is immediately available to fund retirement lifestyle even though generating relatively low income ranging from 3%-6% return. Let us dwell a bit deeper and take a look at the three main mistakes that retirees make regarding their money:
Overlooking the effect of inflation and erosion of purchasing power.
Many people underestimate the amount they spend on their living expenses.
Take the example of Tim, the businessman whose story we began. Tim is planning to retire with a nest egg of RM3mil. He expects to live off the RM120,000 in interest from putting the money in a fixed deposit, assuming that the bank pays him 4% per annum on that amount.
As we pointed out, unfortunately, Tim has overlooked the effect of inflation on his savings. Say that the inflation rate averages 6% yearly. In 12 years, his savings would have halved in value, becoming the equivalent of RM1.5mil today.
And that is not the end of Tim’s troubles. Along with inflation comes the erosion of purchasing power. So, at 6% inflation, in 12 years, the RM120,000 income that he will receive can buy only half of what it gets today. The painful truth is that if Tim lives to 86, he must survive on just one-eighth of his income today.
Not optimising the return on investment of retirement assets.
Like most retirees, Tim has planned to derive his retirement income from the returns on his FD or dividends from his EPF savings. We have seen how inflation and the erosion of purchasing power will put a dent on Tim’s retirement income.
To mitigate the effects of inflation and loss of purchasing power, we should aim to get a return on investment of 7%-9%. By doing so, we will need less capital to fund our living expenses.
Diversify retirement assets
Depending solely on our EPF savings and personal funds during retirement is not advisable, as our assets are not diversified. The idea is not to keep all our eggs in one basket, Contrary to popular beliefs, optimising money is not only about growing our money, it is about protecting it too.
To ensure that our assets are not depleted due to adversities, we should diversify them. For example, we should also consider investing overseas, buying foreign equities, property and unit trusts. This will spread the risk that may affect any one class of assets.
Remember, the golden rule for protecting assets is to diversify. This principle particularly applies in today’s world. Anything can happen in the financial sphere due to increased volatility; case in point, the era of post-2008 global financial crisis.
We can save ourselves much grief if we apply the rules of money optimisation to manage our finances in retirement. Until our retirement, we are used to a certain lifestyle, which we do not have to think about since it is funded from our active income. Whether we rely on our monthly pay or business income, the cash flow is not an issue. No decisions need to be made about where the money would come from. We can afford not to plan our expenditure.
All that changes once we retire. A new task dawns on us. The main challenge is where to find the income to support our lifestyle. Even with property or money in the bank, it is still a heavy responsibility to maintain the flow of funds needed to enjoy modern comforts and amenities.
Two-step Money Optimisation approach
For this, I would like to advocate a two-step Money Optimisation approach. To do this, we should first invest in investments that yield good capital gain, e.g. in properties and equities. The key word here is capital gain. Then, we can use the gain to fund our retirement expenses. In this approach, the capital gain is not immediate. You would need to wait for a few years before the investments make reasonable profits. You must also sell the investment or part of the investment to realise the gain. That is why it is a two-step approach.
In conclusion, learning to optimise money is a must for retirees, not an option. Retirees today cannot retire completely as they have to continue to actively optimise their nest eggs even during their golden years.
Yap Ming Hui (yap@yapminghui.com) heads Whitman Independent Advisors, a licensed independent financial advisory firm which has helped people to optimise their wealth and achieve financial freedom since 2000. The views expressed are entirely the writer's own.
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