Sunday, April 18, 2010

Safer ways of building retirement nest egg

Whenever the topic of building a comfortable retirement nest egg turns up, investing is almost always mentioned. Personally, I would not put investing at the top of the list of recommendations to build retirement fund to the general public. It will be a disaster if your investment gets wiped out just when you are about to retire. In fact, this did happen and the person got so aggrieved that he suggested that CPF funds be banned for investment.

There are less risky ways which I highly recommend to achieve financial independence. They are slower but surer. However, they will not make you very rich but will allow you to retire with dignity and avoid becoming a burden to society. The methods are as follows;

1. Saving money
Unlike investing where luck plays a role (at least in the short-term), saving money is within anyone's control. A middle-income person with financial discipline should be able to set aside at least 10% of their salary per month. Assuming there is no extended period of unemployment, the person should be able to accumulate a respectable nest-egg by the time he retires. My next series of posts will be on saving.

2. Using insurance for protection
Saving money alone is not enough as an unexpected disaster can take them away. You can lead a frugal lifestyle and save lots of money. However, without insurance protection, you can still be bankrupted by unexpected disasters like medical illnesses or accidents that hits you with a huge bill and disables you from earning an income for an extended period of time.

3. Work hard at your job and be good at it
For the majority of us, our major source of income comes from our job. Not many of us can have investment income that exceed our salary. Hence, it makes sense to concentrate your efforts on doing a good job in your career rather than dream of the day when you can shake leg and solely depend on your passive investment income.

Many people have said that one cannot get rich being a salary worker. That depends on who you are talking to. Fund managers, bankers, proprietary traders will disagree. People who work in the highly competitive consumer electronics sector (like me) whose profit margins get squeezed and major companies moving out to China every year will agree. The lesson learnt is to join the right industry. The right industry is the one with the highest median salary.

Speaking from experience, I have seen mediocre people working in the right industry getting paid more than smart people working in a bad industry. If someone is in the right place at the right time, he can work less hard and be less smart and yet earn much more than someone who works very hard and is very smart.

Choosing the right industry is a matter of luck. My advice to fresh graduates is not to choose a job simply because it pays well and end up becoming miserable. I believe it is more important to choose a job suited to your personality and natural abilities so that you can perform well and even come to love it.

4. Arm yourself with financial knowledge to protect against the financial sharks

In a modern economy in which financial services have become dominant, it is important to be financially literate to protect yourselves against the financial sharks who work in this industry. The compensation of Wall-Street kind of jobs is so out of whack with reality that I have to wonder about the source of their income. One income source is the financially illiterate suckers that they prey upon. You can do the right things financially all your life - saving hard and working hard. Without adequate financial knowledge, one commission-minded financial adviser intent on sucking you dry will succeed in persuading you to part with your hard-earned nest-egg. Remember the Lehman Brothers Minibonds?

Sunday, April 11, 2010

Financial literacy is the most effective shield against financial sharks

During the heights of the financial crisis of 2008, a recurring conversational topic were the financial sharks who got rich out of preying on the hard-earned savings of ignorant consumers.

I got some heat when I defended the young relationship managers hired by the banks to meet aggressive sales quota. I did not like the way people called them immoral and greedy. Abhorrent their behavior may be, how they behaved is similar to how the average person would have behaved given the same set of carrots and sticks.

The people at the financial institutions are the ones who are best armed with knowledge to teach financial literacy. However, the unfortunate reality is that they have the least incentives to teach financial literacy but every motivation to spread financial ignorance and even disinformation. When you think about the financial products they sell, maximum profit is made from the ignorance of consumers. It is hard to sell high commission products to a financially literate person. The most lucrative customer (or sucker)  is a rich, ignorant and greedy one. Hence, it is small wonder the retirees are an unspoken favorite target group of the financial sharks.

Ignorance is something all of us can improve on. You do not need to be highly intelligent to conquer it. Conquering it can at least protect the public from making basic financial mistakes like chalking up high credit-card debts to legalized loan-sharks. This is a fast route to bankruptcy. School teachers should use credit-card debts as an example to teach compound interest. This simple act might have saved some of their students from credit-card bankruptcy when they grow up.

It is more effective to work on one's ignorance than to blame "immoral" bankers who are being business-like in maximizing profits.

Another group that often gets the blame during the discussions are the regulators. On hindsight, deregulating the financial sector by Alan Greenspan and expecting the banks to self-regulate was a mistake. In my humble opinion (pardon me if you know better as I do not have a financial background), the mistake made was in expecting that it was in the interests of banks to self-regulate and not commit financial suicide. Actually, it was in the interest of the bankers to take excessive risks, earn excessive bonuses while the dancing carries on, then when the dancing stops, get taxpayers to pick up the tab and eject with a golden parachute (another round of excessive bonus). It was the smartest way to play the game and this is what you would expect when the brightest minds in the world move into the financial sector. This was clearly a case in which the free market fails. Regulators do have an important role to play in situations when the free market fails. Therefore, the solution to the financial crisis must come from the regulators, not bankers. More regulation, not less regulation.

Some victims of the Lehman Minibonds debacle insisted that the regulators should have protected them from the financial sharks. For practical reasons, I do not think it is wise for the public to depend on more regulation for protection.

There are powerful forces set against the regulators to legislate financial reforms. With the money that the financial services industry can muster, they can exert enormous political pressure on the regulators. Given the important role that bankers play in the economy, they will know powerful friends in high places. With their money, they might even have senior politicians in their pocket. They have many trump cards to play with. You can be sure they will play their cards very well as the excessive bonuses doled out will attract the finest minds in the world. Because of the much higher compensation, the regulators are up against superior minds. These problems are not as serious in Singapore as the civil service is known to be relatively corruption-free, fairly well-paid and therefore attracts its fair share of the bright minds in the country.
However, excerpts of this video (scroll to 0:56:34) show that even the most powerful, smartest politician of America with kind intentions to do good for her country has to eventually bow to the political might the financial sharks possess. The politician in context was none other than Mrs Hillary Clinton.

Certain hiring practices of the financial industry (in US) can "corrupt" even the best regulatory system designed with best practices to be incorruptible. By hiring regulators and paying them ridiculous sums of money to leave the job, bankers have carved out a most lucrative career path for the regulators. Existing regulators, consumed with envy and jealousy of the new-found wealth of their former colleagues, will see the bankers as their future bosses. Immense riches shall come to them once they too have successfully made the jump. They have to be careful not to set regulations that hurt the bank's profits because it is not in their interests to hurt their own future profits. In fact, it is in their interests to remove current regulations that crimp their future bosses' profits.  If this can happen in the US, it can happen in Singapore some day because human nature is the same everywhere. Can the people safely depend on their regulators to set policies that protect them?

Hence, the most effective shield the public can use to protect against the financial sharks is to count on themselves in acquiring financial literacy. One of our own regulators, the CPF board, has commendably been doing this job as a service to the public. Please visit their financial literacy website

Another good site which I highly recommend is which requires no introduction for Singaporeans. He is a rare breed who speaks out for people at the expense of his own interest without fear of offending powerful forces related to the financial industry.

Sunday, April 4, 2010

Importance of emergency cash reserves

I have a policy of keeping sufficient cash reserves to meet life's misfortunes. The common risks in life that I can think of are unemployment, medical illnesses, accidents. Risks such as medical illnesses and accidents can be transferred away through insurance. Insurance premiums are fixed costs, so they make financial planning easier as they bring more certainty to the specific risks. This helps one to reduce the size of the cash reserves to be set aside. Generally, when the risks are more uncertain, one has to set aside a larger cash buffer for protection.

In the event of unemployment, I set aside 6 months worth of cash to meet expenses which cannot be avoided. This includes basic living expenses, debt payments and parents' allowances. Although my parents will probably refuse to accept any money should I become unemployed, I think it is a good policy to set aside this money anyway.  Children have a greater chance of becoming filial when they grow up when the parents exhibit similar behavior themselves. Therefore, undisrupted payment of parents' allowances despite adversity is a good policy of securing one's retirement in old age because it nurtures filial children who provide retirement support.

As a person grows older, I think 6 months worth of cash will not be sufficient for protection. For the average worker, it is harder to find a job if he gets retrenched at an older age and even when he does, a pay cut is almost inevitable. Therefore, he should set aside at least 10-15 months worth of funds as he grows older depending on how confident he is in finding new sources of income soon.

Besides unemployment, there are other risks in life that cannot be insured away. One risk that presents particular headache to me is parents' and parents'-in-law medical bills as they near the end of their lives. It is very hard to estimate how much this will cost because it depends on how they die. If they were to die a slow death, organ by organ, the doctors will eat up my nest-egg. Because of the uncertainty, one has to set aside an out-sized amount. It is a burden that one has to carry to avoid the regret and guilt of causing the old folks' deaths by denying them medical care. The younger generations of Singaporeans will have to bear even heavier burdens as parents have fewer kids and their life expectancy lengthens. It is incumbent on every parent to start preparing for their retirement to prevent such issues from souring family relationships.

On top of the cash reserves that I set aside for the above considerations, I added another 10%-15% as a margin of safety to meet life's unknown or even unexpectable risks. I think this is reasonable because no one can think of all the possible risks ahead.

Those who invests in the stock market may be tempted to put the emergency cash reserves into it. Indeed, I was tempted when I started out in the stock market. Thankfully, I did not. Like most amateurs, I lost money. However, at no time did I put my family finances in danger because the cash reserves were untouched. An advantage of having ample cash backup is the psychological support it provides which gave me a cool head while others in the same predicament were losing theirs. This is very important in investing as the right psychology plays a big role in success. An investor who becomes disheartened by losses will not be able to recover his losses when the bull market returns.

Some newbie investor will ask "what if they do not have such a cash reserve"? Then, don't invest. My order of priority is to first, buy insurance for protection, then save hard to build up a sufficient cash reserve and finally, invest the rest which represents money that can be lost 100% without danger to the family's finances.