Concluding Post on Early Retirement

I first blogged about early retirement about a month ago. Perhaps because it is a topic that is seldom explored, the insights on the topic has been tremendous. It is worthwhile to summarise in one post all the insights on the topic.

Is Your Financial Freedom Conditional? 

If you are thinking of early retirement, it is probably because you have or about to achieve financial freedom from your job. You probably have a regular stream of passive income from your dividends and/or rental income to cover all your expenses. However, as explored in Can You Count on REITs for Retirement? and How Much Does One's Financial Independence Depend on One's Health?, is this financial freedom conditional upon things remaining the same as they are today? What happens if the economy goes into a recession, possibly bring asset prices, dividends, interest rates and currencies down along with it? There might even be massive rights issues on your stocks or REITs as happened during the Global Financial Crisis in 2008/09. Would your passive income still be sufficient to cover all your expenses and allow you to continue your early retirement? If you have to emerge temporarily from retirement to tide through such difficult periods, it should be noted that it might not be so easy to find a job during recessions, especially if you are out of the job market for a prolonged period of time. 

On the expenses side of the equation, will there be unexpected large expenses later down the road that could not be covered by your passive income, such as overseas education for your children and/or medical costs for your close ones? All these unexpected expenses may cause disruptions to your retirement and it is best to have sufficient buffer in your passive income before you embark on early retirement.

Retirement is only the Beginning of the End

The common perception is that retirement is a destination that you reach after working, saving and investing diligently for 20 to 30 years. After retirement, you just need to enjoy life using savings from your retirement nest-egg. However, retirement is only the beginning of the end of the financial journey. As discussed in The Great Retirement Challenge, there are still 20 to 30 years of retirement spending to be managed. It is like you spend all your life since you started working climbing up a mountain and finally reaching the peak, only to realise that you still have to climb down that mountain! And the down-hill path is even more treacherous than the up-hill path. Any mistakes on the down-hill path could be difficult to recover because you no longer have time and labour capital on your side.

The most ironic part is the tools that you have for accumulating the retirement nest-egg on the up-hill path (i.e. dollar cost averaging and portfolio re-balancing) have become the obstacles on the down-hill path! When I first understood the beauty of dollar cost averaging and portfolio re-balancing, I thought that there is finally a free lunch for investors. It turns out that there is really no such thing as a free lunch. If you look high and low for the bill and still could not find it, it is because the bill has not yet arrived! So, while the lunch is still free, you might want to enjoy the free lunch and defer the bill for as long as possible!

Retirement is a Mindset

If all the above discussion sounds demoralising, you may wish to note that retirement is a mindset. If the work you do everyday is something that you are passionate about, there is no need to talk about retirement. Everyday would be a day of fulfilment of your passion, and there would always be something still unfinished at the end of the day that motivates you to continue and finish it the following day.

Finally, you may have heard the story about a rich CEO who works very hard for many years so that he could one day relax and engage in his favourite past-times versus the poor fisherman who has no assets to his name but could also do the same after fishing for a few hours in the morning. Who says that you need to have $1 million or more to retire comfortably? If you have to work for a few hours each day, but gets to enjoy the rest of the day, is it not retirement too?

See related blog posts:

• Retiring at 40
• Thoughts on Early Retirement – A Year On
• Early Retirement Maybe A Luxury That I Cannot Afford

OCBC360 vs UOB One: The Verdict

I hope the web calculator that I put up last week has been useful in helping readers to decide whether the OCBC360 or UOB One account is better for them. I have since enhanced the web calculator to include credit card rebates. However, the focus of today's blog post is not on the web calculators, but on the guidelines and charts to assist readers to understand better the scenarios in which either of the accounts is better.

If you have played with the web calculator, you would realise that while the calculator can tell you precisely which account is better for a certain scenario, it does not tell you under which scenarios would one account be better than the other. Furthermore, the amount of money that you can have in the account is not static; it varies over a range depending on cashflows. Depending on the amount of money that you have in the account, one account might pay better for certain account balances while the other account might pay better for other account balances even if all other parameters remain the same. This is where guidelines and charts can provide better clarity than web calculators.

To recap, there are 4 parameters affecting the interest rate than the banks will pay on the account. These are:

1. Credit your salary of at least $2,000
2. Pay at least 3 bills through GIRO
3. Spend at least $500 on credit cards
4. Invest or insure through the bank

On top of that, there are different interest rates for different tiers of account balances. In total, there are 5 tiers, namely $10,000, $30,000, $50,000, $60,000 and above. Please refer to OCBC360 vs UOB One: The Calculator for the interest rate payable for the different parameters and account balance tiers. Due to the numerous possible permutations, it is difficult to tell which account pays better. The figure below shows at one glance the effective interest rate for the different parameters and account balances.

Effective Interest Rate for Different Banking Activities & Savings

The column for "OCBC" shows the interest rate for the various parameters for account balances up to $60,000. The columns for "UOB" show the effective interest rate for the various parameters and account balances up to $60,000. As an example, if you satisfy all the parameters and have $40,000 in the account, UOB will pay an effective interest rate of 2.21% on the $40,000 balance.

For every cell in the "UOB" columns, they are shaded either in red, yellow or blue. The colours show whether OCBC pays better (red), UOB pays better (blue) or equal (yellow) for that scenario. Thus, for rows that have a single colour across all columns, it means that one bank pays consistently better for all account balances and you can safely deposit your money with it. For rows that change in colour, you need to be more precise to know which account pays better. For example, in the row "Yes/ No/ Yes/ No", OCBC pays better for balances less than $20,000 while UOB pays better for balances more than $20,000. If your balances fluctuate around $20,000, then no single account stands out and either account will be suitable for you. For a precise computation of the interest rate payable by both accounts, please refer to the web calculator: The OCBC360 or UOB One Calculator (Basic).

Thus, OCBC pays better for most of the scenarios while UOB pays better in a few specific scenarios. Let us hope that UOB will enhance its offerings to catch up with OCBC!

Moving on to the enhanced web calculator as mentioned earlier, it takes into account credit card rebates offered by specific credit cards for a more comprehensive understanding on which bank (savings and credit card) pays better. For OCBC, the Frank credit card which pays 6% rebate for online spending is assumed in the computation. For UOB, it is the UOB One card which pays up to 3.33% in rebates. While the enhanced web calculator provides a more comprehensive analysis than the basic one, there are more rules and conditions to be satisfied. Readers are advised to read the terms and conditions of the 2 credit cards to understand when rebates are payable:

• OCBC Frank Credit Card: http://www.frankbyocbc.com/products/cards/credit-card/
• UOB One Card: http://www.uob.com.sg/personal/cards/credit/uob_one_card.html

The enhanced web calculator is accessible here: The OCBC360 or UOB One Calculator (Advanced).


See related blog posts:

• OCBC360 vs UOB One: The Calculator
• The OCBC360 or UOB One Calculator (Basic)
• The OCBC360 or UOB One Calculator (Advanced)

OCBC360 vs UOB One: The Calculator

One of the shortcomings of a blog is that the information shown is static, meaning that while we could discuss guidelines and present charts, these guidelines and charts might not quite apply to everybody's situation. A case in point is the question whether the OCBC360 or UOB One account pays better. Depending on your situation, either one could be better, but guidelines and charts do not quite reflect your situation accurately. Hence, this blog post is a proof-of-concept to create a dynamic web calculator that takes in your input and compute which account is better for you. Having said that, guidelines and charts are still useful in discussing overall situation and dynamic calculators serve as a complement to guidelines and charts.

Interest Rates

First, an introduction of the 2 accounts. Basically, both OCBC360 and UOB One accounts offer higher interest rates if you are able to broaden your banking relationship with them, i.e. if you can credit your salary, pay bills through GIRO, use their credit cards and invest or insure with them, they will offer a higher interest rate on your savings, up to a certain threshold. The details of the 2 accounts are as follow.

Interest Rates of OCBC360 Account

Interest Rates of UOB One Account

However, both accounts differ in the amount of additional interest rates payable for each type of banking activity and for each level of savings. Due to the numerous possible permutations, it is difficult to tell at first hand which account pays better.

Web Calculator

To assist you in computing which account pays better in your situation, I have come up with a basic web calculator. You can access The OCBC360 or UOB One Calculator here.

See related blog posts:

• OCBC360 vs UOB One: The Verdict
• The OCBC360 or UOB One Calculator (Basic)
• The OCBC360 or UOB One Calculator (Advanced)

Can You Count on REITs for Retirement?

When the CPF Advisory Panel announced recommended changes to the CPF system early this year, there were some suggestions on the ground that retirees withdraw the amount above the Basic Retirement Sum of $80,500 at age 55 and invest into REITs. This way, they could start receiving income from 55 years old onwards instead of having to wait till 65 years old to start receiving income from the CPF Life scheme. I am not sure if this is a good idea.

As a retiree, you would hope to receive stable or increasing passive income from your investments. How would the distributions from REITs appear to a retiree? The figures below show the annual distributions from REITs listed on Singapore Exchange that have a history of at least 8 years. Note that the distributions are unadjusted for any corporate actions such as rights issue. This is because, to a retiree, he might not be able to fork out money to participate in any rights issues. The distributions shown below are thus for one unit of REIT held from IPO till now.

Annual Distribution from REITs (IPO Before 2006)

Annual Distribution from REITs (IPO in 2006)

As shown in the figures above, the distributions are vulnerable to large rights issues such as those that occurred during the Global Financial Crisis (GFC) in 2008/09. Many REITs had to issue large rights issues during that period to re-finance the debts on their balance sheets. Some of these rights issues were almost 1-for-1 rights issues at near 40% discount to the prevailing market prices (which had already fallen off steeply)!

To a retiree who could not afford to fork out money to participate in the rights issues, he would have seen his distributions from REITs falling by as much as 40% for some REITs. The distributions from some REITs have not recovered to their pre-GFC peak even today.

Post-GFC and post-rights issue, the distributions from REITs have generally increased. However, there are also signs that the distributions have tapered for some REITs. The reasons for the distributions tapering off are due to firstly, the pace of acquisitions of new properties and/or Asset Enhancement Initiatives reducing in recent years. This is the same reason as discussed in REITs Are Not Forever Attractive. Secondly, there is regular dilution due to new units being issued to pay for the REIT management fees and Distribution Reinvestment Plans. If the increase in rental income is unable to outpace the increase in no. of units, the per-unit distribution will taper off or decrease. If the above trends continue, unitholders are likely to receive lower distributions from the REITs going forward.

Thus, are REITs a good retirement asset for retirees, especially those who do not have other sources of income? Nevertheless, I have to acknowledge that for retirees who need to sell down their assets to fund their retirement, there is still a role to play for REITs. See The Great Retirement Challenge for more info.

Lastly, for those who have sufficient passive income and are thinking of a "travel-around-the-world" type of early retirement (as opposed to a "keep-yourself-busy" type in which you might still have some active income), the above figures show that perhaps the most appropriate time to think about early retirement is at the depth of an economic recession. That would be the time when dividends/ distributions from stocks and REITs are reduced, interest rates on bank savings are cut, currencies are devalued, massive rights issues are being held and you know of someone close to you who is retrenched. If your passive income is still sufficient to handle your expenses after all these, then you are truly well on your way to an early retirement!

See related blog posts:

• REITs Are Not Forever Attractive
• The Great Retirement Challenge
• Should First Reit Be Given a Second Chance?

The Great Retirement Challenge

Congratulations! You have finally accumulated $1 million in assets after working, saving and investing diligently for 20 to 30 years. The next question is, how do you convert $1 million in assets into $1 million in income streams to support your retirement? This is the question that I encountered as I thought deeper about Retiring at 40.

Many people hope that they do not need to draw down on their accumulated assets as they enter into retirement. This is a very important psychological consideration, because, if you need to draw down on your assets, how do you ensure that they will not be completely depleted before you leave this world? You would be living in constant worry, unless you have additional income streams from children and/or annuities that could last you forever.

There is another equally important reason why you should avoid drawing down on your assets. When you have to draw down on your assets to support your spending, it means that you have no choice but to sell regardless of what the market conditions are. When you have to sell in a bear market, your assets will actually deplete faster. For example, assuming that you need to spend $40,000 every year, but the market has declined by 50%  (i.e. your assets are now worth only $500,000), you would need to sell 8% of your reduced assets to achieve the same dollar amount of spending. This is actually the reversal of the Dollar Cost Averaging (DCA) methodology. All the benefits of DCA and all the discussion about Volatility is Your Friend are now reversed. To put it in another way, DCA which is your greatest friend in helping you to accumulate that $1 million in assets has become your greatest enemy when you try to cash out the assets. 

Based on the above considerations, all your spending needs must be met by dividends (and capital gains if available). On up of that, there is inflation to be protected against, to ensure that your spending power is not eroded over time. The average inflation rate is around 2% to 3% in the last 15 years. Based on 4% spending rate and 3% inflation, you will need to grow your assets by 7% each year during your retirement period. This is actually not a low figure. 

Let's assume further than stocks can generate 3% in dividends and 7% in capital gains each year on average, making a total of 10% gain. Bonds, on the other hand, can generate 4% in dividends but no capital gains. To achieve the 7% target growth rate, you would need to allocate 50% in stocks and 50% in bonds. The allocation to stocks is actually higher (i.e. more aggressive) than the common rule of thumb that says the allocation to bonds should be your age in percentage. 

Based on the above 50-50 allocation, the annual dividends generated is only 3.5% (1.5% from stock dividends and 2% from bond coupons), which is actually lower than the 4% spending rate. Thus, if you stick to the target spending rate, you will actually need to draw down on your assets. What are the options available?

Reduce Spending Rate

The safest way is to reduce your spending rate as a percentage of your assets. This means either reducing the spending amount per year to $35,000 or less, or increasing your assets to $1.15 million.

Increase Dividend Yield

The most obvious, but potentially dangerous, way is to increase your dividend yield by buying higher-yielding assets. This usually leads to some other bigger risks. For example, junk bonds have higher yields, but they also have higher default rates. It is not worth risking your assets for 2-3% higher yields, especially when you have retired and cannot make up for the loss through working.

Hold Yield-Generating Depreciating Assets

There are some investment assets that produce regular income for a period of time but the value declines over time. Examples would be leasehold properties and Real Estate Investment Trusts (REITs) that hold them. Before the lease expires, the property will generate fairly high rental income, especially if debt is used to buy the property, but the property will decline in value as it approaches lease expiry. Such depreciating assets can generate higher yields that stocks, because they do not need to deduct depreciation charges from earnings before distributing the income. 

The higher yields from depreciating assets can help you in avoiding having to sell the assets regardless of market conditions, but you must be prepared for a gradual decline in price as the properties approach lease expiry. In other words, you cannot expect to buy a REIT at $1, collect 6% yield for 20 years, and still sell it at $1 or more. You may wish to refer to REITs Are Not Forever Attractive for more details.

Sell Assets

As a last resort, you will need to sell and draw down on your assets. The key risk factors mentioned in paragraph 3 above are (1) the need to sell regardless of market conditions and (2) unpredictable volatility in the market. If you can tackle either or both of the risk factors, the consequences of drawing down on your assets are much more manageable. For example, if you have the choice not to sell in a bear market, it will protect your assets to a large extent. Alternatively, if the market can be predicted accurately to fall by a fixed percentage each year, you could calculate with much better precision when your assets will run out if you have to draw down on your assets.

This will be the subject of much thought in future.

Conclusion

It took me 29 years (and still counting) to learn how to invest. It will probably take me an equally long period of time to learn how to divest. When I set up this blog, the title of my first blog post was The Beginning of the End, which was a reference to "The Matrix" movie, as I believe that the stock market is a Matrix which clouds people's thinking and makes people behave differently from the real world. It is ironic that the start of retirement is not the end of the financial journey, but only the beginning of the end.

See related blog posts:

• Can You Count on REITs for Retirement?
• Concluding Post on Early Retirement
• Thoughts on Early Retirement – A Year On