Tan Kin Lian's Blog: Accumulation of Savings

Tuesday, September 29, 2009

Accumulation of Savings

This table shows the accumulated amount of savings at various rates of interest, and the reduction caused by the charges taken away from your savings by the financial product.

For example, if you save $500 a month and earned 5% per annum for 35 years, you will get an accumulated amount of $569.018. If the financial product takes away 2% per annum (which is quite common) to give a net return of 3%, you will get an accumulated amount of $373,656, or a reduction of 34%.

A good financial product will take away a reduction of 0.5% leaving you a net yield of 4.5% and an accumulated sum of $510,894 or 37% higher than $373,656. An example is an exchange traded fund (ETF) or a low cost unit trust.

Choose a financial product that takes away not more than 1% of your yield. Avoid financial products, including most life insurance policies, that takes away more than 2% of your yield, leaving you with a poor return.

When you buy a life insurance policy, you get a benefit illustration. Look at the figure shown as "reduction in yield". You will find the reduction to be more than 2%. If you do not know where to find it, ask the insurance agent to tell you (it is the duty of the agent to explain this infromation to you).

If you have already bought a whole life, endowment or investment-linked policy, or a variation of these plans, you can ask the insurance company to send you the benefit illustration again and tell you about the reduction in yield.

A survey carried out in my blog indicated that 80% of people who bought a life insurance policy were not told about the distribution cost (which causes a large portion of the reduction in yield) and, after learning about it, almost all of them felt that the distribution cost is too high. They felt that the agent should have told them about it.

The remaining 20% who were told about the distribution cost could have bought a single premium policy where the distribution cost is quite small and is likely to be explained by the agent.

Tan Kin Lian

Note: This new chapter will be added to my book on Financial Planning: Practical Steps

12 comments:

Tan Kin Lian said...: The figures in this table are obtained using the function FV in Excel. You have to provide the following parameters:

Rate of interest, e.g,. 0.05 for 5%
Number of payments, e.g. 35 (for 35 years)
Payment - annual amount, e.g. $500 X 12 = $6,000
Present value - $0
Timing of payment - use 0.5 to show the the annual savings of $6,000 is paid, on average, at the middle of the year.; September 22, 2009 7:48 AM
Anonymous said...: I think it is also worth highlighting that when diversifying, investors should think global as opposed to local.

If you invest all of your money in a small market like Singapore via an STI based ETF, then you expose yourself to a high amount of systematic risk should something go wrong in Singapore. This risk is even higher if you consider that the rest of your assets (house, bank deposits etc) are all Singapore based. Here it should be noted we do not have to have a major disaster for your portfolio to lose money. If MAS decides for "strategic reasons" to devalue the Singapore dollar by say 30%, then your asset portfolio will lose a substantial amount of value.

When considering where to put your money, you might therefore want to consider splitting up your money to cover US and Western Europe. This could be in the form of a US/Western Europe based ETF or unit tust with low expense ratios. These markets have strong and transparent regulatory environments. In the event of a scandal, the democratic political environment in such countries are such that the governments will help investors as opposed to blame them for going in with their eyes open. Also to further protect yourself from currency risk, you might want to consider funds denominated in US$ and Euros respectively.

Also avoid emerging markets like China,India,Russia, Estern Europe etc where regulations are weak and insider trading/stock manupilation is rampant.

No one can predict where the stock markets or currencies will go. By having a properly diversified global portfolio, you are however able to minimise risk by minimising the impact of systematic events.; September 22, 2009 11:31 AM
Anonymous said...: Aurvandil,

Those who are seriously thinking in the scenario that you have painted have probably migrated or in the process of migrating.

Those who still remain will still remain come doomsday for Singapore.; September 22, 2009 1:31 PM
Vincent Sear said...: A lot of people probably are aware, even taking it for granted as standard industry practice, that for participating insurance, there's no cash value in the 1st 2 years.

Some don't really be bothered. They plan to pay for say 30 years and jump straight to look at the projected returns 30 years later. If the net yield, premium and coverage look acceptable and worthwhile to them, they won't mind where the reduction in yield goes to.

Some may even have by straight logic figured out in their hearts quietly, the missing cash values for the 1st 2 years go mostly to commission and other expenses. That's why it's not uncommon (at one time even rampant) that prospective clients ask agents for "1st year discount" in the form of rebate from 1st year commission which can be from 30 to 60% depending on the company and the policy. This practice is supposedly outlawed by MAS directive but in reality, hard to detect.

I'm not sure if MAS have but think they should come out with a clear directive on fee-based financial planning and rebating of commission.; September 22, 2009 5:15 PM
Anonymous said...: Hi Mr Tan n all,
Buying unit trusts(ut) from fundsupermart (fsm), do you consider it as low cost ut? Since fsm has an initial sales charge of 1%-1.5% for equity and also an annual expense ratio of the ut..
thks in advance; September 22, 2009 9:42 PM
Anonymous said...: What you all think about myhome fund by POSB? Worth to invest?; September 22, 2009 11:09 PM
Tan Kin Lian said...: Reply to 9:42 PM
I invested in FundSupermarket and chose a fund with 2% sales charge and 1% annual fee. I consider this to be high, but I have no choice. Other channels charge higher fees.; September 24, 2009 6:53 AM
Vincent Sear said...: I think that FundSupermarket and DollarDex charges of average 1% (bond funds), 2% (equity funds) and 3% (specialised funds) are fair, as long the annual management charges of the funds chosen are also fair. Both adds up to total costs, not just one or the other.

High front-end sales escalated in the US to as high as like 8.5% for "brandnames" like Templeton in the 70s and 80s and blown over with the 1987 stockmarket crash. It spiralled down in the early 90s until there's a whole new class of so-called "no-load" funds @ 0% and "front-load" funds stabilised @ 3 to 5%.

However, it doesn't mean one or the other is necessarily cheaper. There's time frame and overall expense ratio as no-loads are also allowed to charge "12b1" distribution cost that's annualised like management charge. To put it simply, the distribution cost is not waived and disappeared, it's just simply annualised instead of being lumped upfront.

There's another model of load, the "backload", i.e. neither upfront nor annualised but a charge at redemption (e.g. starting at 5% if redeemed in the 1st year and gradually diminishing till 0% at a certain anniversary). This is less common with retail funds and more common with specialised hedge funds.; September 24, 2009 11:16 PM
Anonymous said...: The magic word is to "diversify". Savings should be parked in deposits, equities, fixed assets etc. Not all into one basket. Much depend on one's mind when it comes to how much one can afford to loss; and how much one is willing to loss.; September 29, 2009 12:39 PM
Unknown said...: I would like to gather some advice from investors who bought PRU 3 PLUS from Hong Leong Finance.
I bought this product from the FI in 2008 and has since complained to FIDREC about miselling of the product. The results are out but I am unsure of what to do.
They have proposed to pay back 50% of what I have lost after selling which is abotu 5K. It only matures in August 2011.

Thank you
JL; July 18, 2010 11:11 PM
Anonymous said...: I agree that life insurance is not necessarily an investment, but it is a very powerful financial tool if used properly. But there are savings plan available in the market which are with less risk; January 17, 2012 4:45 PM
Anonymous said...: Are UT Regular Savings Plan considered as good investment? Am planning to start one with FundSupermart. Please advise.; February 10, 2012 5:34 PM