Early Retirement Maybe A Luxury That I Cannot Afford

I have blogged about early retirement in the past 2 years, but I really do not intend for this to be an annual series. Moreover, I do not intend to retire early and sit back and do nothing. Nevertheless, there are fresh insights on this topic and it is good to write them down for future reference. 

In the past 1 year, I have read a few books such as "Capital in the 21st Century" and "Rise of the Robots: Technology and the Threat of a Jobless Future". I am concerned about automation and robots taking away jobs. By right, this should not be a concern for someone who has considered early retirement. However, there are additional complexity if I think about future generations. I do not have any children currently, but if I have, then any actions on my part now would have an impact on them in the future.

I do not think I will be replaced by automation and robots any time soon. However, the same cannot be said for the next generation. If the doomsday scenario of robots replacing workers on a wide scale were to materialise, it means that we are back to the very old days when how well we live does not depend on how hard we work, but who our parents are and/or whom we marry. In the case of my children (if any), that parent would be me. Thus, when seen from an inter-generational perspective, the window of human employment is closing soon and early retirement at a time when jobs are still available seems a luxury. Hence, instead of saving enough for my own retirement and retiring early, I should work for as long as possible to maximise the income from human capital and build up sufficient financial capital upon which my descendants could lead a decent life. Early retirement maybe a luxury that I could not afford in the face of automation and robots.

Of course, this is not a fool-proof plan. Whatever I save could be squandered away by future descendents. So, I do hope that the doomsday scenario of robots replacing workers will not happen. Or perhaps the prevailing governments of the day would understand the social implications and implement some basic income for citizens as suggested in the books mentioned above. If I have to pay more taxes for this to happen, I would grudgingly pay them. It is a small price to pay for social insurance for my future generations.

Having said the above, if I can have the option of not relying on some external parties to bail us out, that would be the best. Thus, I will have to use my own efforts and earn as much as possible. Sorry, folks, I have to go back to work tomorrow.

See related blog posts:

• Concluding Post on Early Retirement
• Thoughts on Early Retirement – A Year On
• The Great Retirement Challenge

Thoughts on Early Retirement – A Year On

Nowadays, seldom do anyone blog about early retirement any more. About a year ago, after I past my 40th birthday, I went through a thinking exercise about early retirement and thought about what should I do if I were to retire, how should I fund my retirement, what are the challenges in retirement, etc. You can read more about these issues in the following blog posts:

• Retiring at 40
• The Great Retirement Challenge
• Can You Count on REITs for Retirement?
• Concluding Post on Early Retirement

It is about a year later, and no, I have not retired. If you read my earlier posts, you would know that I am not a fan of the "not-working" type of early retirement. However, I am open to the idea of the "keep-yourself-busy" type of early retirement where you might still work for something that you like but not for the sake of making money. 

One year later, what additional insights have I gained about retirement? Currently, we have encountered major volatility in the financial markets in the past 6 months, whereby stock prices have fallen sharply, property prices have peaked, stock dividends are cut, REIT distributions are tapering off, interest rates are rising and regional currencies are falling. On top of that, there are worries about a possible recession and people being laid off. All these make for a difficult time for a retiree. This validates the point that I made in Concluding Post on Early Retirement, where our financial freedom might be conditional on financial markets remaining steady. While we do not need a bull market to be financially free, a bear market could put that financial freedom at risk.

Even so, the current stock market rout has taught me something about retirement planning that I had not foreseen earlier, which is that you need to plan ahead for retirement and de-risk in advance. Prior to the stock market rout in Aug, my portfolio was not under stress and I had around 53% in war chest, which appeared sufficient to provide a comfortable cushion to handle any stock market decline even if I were to retire early. That war chest has since declined to 35% due to a major investment and bargain hunting. It is still facing downward pressure as attractive bargains remain. In other words, cash that is meant to be deployed as war chest into the stock market in times of market declines is not free cash available for retirement. Cash meant for retirement must be separated from cash kept as war chest. That means that prior to actual retirement, the portfolio must be de-risked in advance. It is not possible to retire immediately even though cash appears to be sufficient when times are good.

The second thing I learnt is that when you either run out of war chest or are reluctant to dip further into your war chest, a monthly salary is still the most reliable means of funding your stock purchases. Even though stock dividends and REIT distributions might be sufficient to cover your expenses in retirement and add to your war chest, they do not arrive at the time when they are most needed. Most of the listed companies in Singapore have December as their financial year-end, which means that the majority of dividends are only paid in May. Outside of the dividend-paying months of May, Aug, Nov and Feb, you can only wait if you do not have other streams of regular income.

I still have some more years to go before I actually retire. Still, the thinking exercise in early retirement has been a very fruitful exercise and provides useful lessons in how we should plan and execute our retirement correctly.

See related blog posts:

• Retiring at 40
• Concluding Post on Early Retirement
• Early Retirement Maybe A Luxury That I Cannot Afford

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

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

Retiring at 40

Most people hope to retire before the age of 40. I just reached my 40th birthday 2 months ago, but no, I did not retire before that day. The idea of retiring before 40 does not sit well with me. Even when I am on vacation leave, I would try to fill up the day with some activities so that I would not feel the day is wasted. Hence, the thought of having to think about what to do everyday for the next 40 years really shudders me. In fact, I am actually thinking of working beyond the retirement age of 65 to keep myself occupied!

If you have been following the Tree of Prosperity blog written by Christopher Ng, you would know that he succeeded in retiring before 40. He is actually my senior in secondary school, junior college, university and post-graduate studies. Compared to him, I knew that I was not ready to retire before 40. He has been growing his dividend income steadily, and has written not 1, but 3 books on that topic! As for me, I am new to dividend investing, preferring to fish for multi-baggers and occasionally ending up with salted fishes. He has settled down with a family while I do not yet know the financial demands of a family with kids. So, really, retirement before 40 is out for me even if I had wanted it.  

By right, the story should have ended here, if not for the fact that it is the 40th birthday. The 40th birthday is a funny milestone. It represents the mid-point of your life. You could also divide 40 by 2 and look back at the time when you were 20, when you were just stepping out into the world, to see if you had made the right decisions then. You could also look forward to see if you wish to continue your life the way it is now. 

As I think deeper on the topic, I realised that retirement is not about leaving the workforce and enjoying life. True, you might relish the luxury of waking up later in the day and spending time doing things that you really want to do but could not find the time to do while you were still working. You might even go on a round-the-world tour with your family. But how many times could you tour the world? Even the best things in life could get boring if they are repeated too many times. So, what do you do after you finish touring the world 5 times over? 

You get back to an "occupation", something that will soak up your time. But there is a difference between the work that you do before 40 and the occupation that you have after 40. Before 40, work is a "chore". Something that you need to do to put meals on the dining table. The work that we do sometimes might not be what we really want to do. It could be because we did not know what we wanted to do when we were 20, or it could be the circumstances that forced us to take the jobs available to us then. After 40, if you have attained financial freedom, occupation is a "choice". Something that you do, not because you need to bring the bacon home, but to fulfil the purpose in your life. It could be something that you are deeply passionate about, such as a hobby or a charitable cause. It is the sort of things that will form your legacy. For example, your legacy could not possibly be "I worked at XXX company, helping to grow sales by 20 times over 20 years!". Instead, your legacy could be "I wrote a blog that helps to promote financial literacy" or something bigger. So, when I heard that Christopher is studying for a law degree, I did not think that he is coming out of retirement because he has "no choice". On the contrary, I think he is pursuing his retirement fully. 

It is interesting to note that Christopher and I could not have been more different in actions. At one end, he has retired before 40 while at the other end, I am thinking of working beyond 65. Yet, both of us reached essentially the same conclusion on what retiring at 40 means.

P.S. Special thanks to Christopher for allowing me to discuss our views on this topic.

See related blog posts:

• Concluding Post on Early Retirement
• Thoughts on Early Retirement – A Year On
• Early Retirement Maybe A Luxury That I Cannot Afford