China stocks are too expensive

There is a report in the Straits Times on Saturday. It mentioned that some of the China stocks are traded in Hongkong and in Shanghai. The price in Shanghai can be up to 9 times of the price in Hongkong. This shows how highly priced it can be.

If you invest in a China fund, are you paying too high a price for these stocks? Will it continue to go higher? Or will it head for a crash?

I prefer to buy these stocks in Hongkong at a fraction of the price in China. When more people in China buy the Hongkong stocks (which are relatively cheap compared to China), the price differential should narrow.

However, the prices in Hongkong may still be too high (based on price earning ratio), compared to stocks in other parts of the world.

Lesson: If you do not know the market, it is best to avoid investing in the over-priced stocks.

Choose the right fund

Dear Mr Tan,

There are so many investment funds in the market. How do I make the right choice? Should I chooce the China and Indian funds that are likely to do well over the next few years? Any advice?

MY REPLY:

Choose a large, well diversified fund fund that have low upfront and annual expenses. Preferably, chooose an indexed funds, such as the STI ETF (exchange traded fund) or the S&P 500 fund (in America).

Invest 80% of your savings in these funds. For the remaining 20%, you can choose the fund that appears to be exciting, such as the China or India fund. However, you must select carefully, as the stocks in China are now too highly expensive.

Educate the customers

Many insurance products are too complicated. The agent does not spend time to explain the product to the policyholder. They are trained to sell the products to the customer, using emotive reasons.

As a result, many policyholders, including those that are well educated, do not understand the product that they have bought.

This is an unsatisfactory state of affairs. It has been the case for many decades.

I personally share some of the blame for this state of affairs, as I had been involved in running an insurance company for 30 years. At least, I tried to offer simple products at low cost that give better value to the customers. And I did try to give simple explanatory leaflets.

I hope that, in the future, the insurance industry will put more effort in the following:

1. simplify the product
2. educate the customers
3. empower customers to select the product that best suit their needs.
4. reduce the upfront and operating costs, and disclose them to the customers.

Need for financial discipline

Dear Mr Tan,

You advocate the strategy of buy term and invest the rest in your blog.

While I personally practise this as well, I wish to add a word of caution as well.

This strategy is not suitable for everyone. People who are spendthrifts may not be able to execute this strategy well. People who are naturally risk-adverse (to the point they avoid risk) are not suited too.

Another group who is more 'greedy' should not use this strategy as well. This is because they will not win in the emotional game of investment. It is likely their investment portfolio will be overly focused and carry too much unsystematic risks.

I hope you can add this word of caution in your blog and spur some discussion on this topic.

My worry is that people may just read your blog and make a decision without a deeper assessment of whether they can execute buy term and invest the rest well.

MY REPLY:

Thank you. Let me see how to encourage people to exercise more financial discipline.

A life insurance policy (such as whole life or endowment) is supposed to force people to have the financial discipline. But, it has not worked well.

If the policyholder is not able to continue paying the premium, the policy will lapse, and they will lose part or all of their savings. A high percentage of policies does not reach the maturity date, causing loss to the policyholders.

In my view, the solution is:

* educate the consumer
* design products with low upfront load and low expense ratio
* offer terms that are fair to consumers.

The Central Provident Fund fits into this criteria.

Longevity insurance - What are the Options?

The Straits Times published my article in their Review section on 21 September 2007.

I explained the increasing life expectancy and the high proportion of people that will survive to 85 and 95. This is higher than what most people think.

I estimated the cost at age 55 of buying the longevity insurance which pays $300 a month from age 85 for the rest of the lifetime, as follows:

                                       Male   Female
No increase, no refund                $6,818  $ 8,759
No increase, with refund              $9,824  $11,594 
Increase by 2% yearly, no refund     $15,137  $19,548
Increase by 2% yearly, with refund   $28,923  $32,991

With refund: the original sum is refunded (without interest) on death of annuitant
Increasing payout: the amount increase by 2% yearly from the time of purchase.

I recommend to buy the increasing annuity, with no refund for those who do not have any serious medical problem. For those who are in poor health, they should buy the increasing annuity with full refund.

Life annuity pays out more

A life annuity can provide a better lifetime income, compared to a fixed term annuity.

A male at age 65 can invest $150,000 in the following:

                                             
Payable for 20 years               $902   
Payable for 30 years               $709   
Payable for life - no refund       $929   
Payable for life - with refund     $827   

If he choose a fixed term annuity (20 or 30 years), he will get a monthly payout of $902 or $709 respectively. The money will run out at the end of the fixed term. In the event of death during the term, there is some money remaining that can be paid to the estate.

There is a 52% chance of surving to 85 years and 24% to 95 years.

If he choose a life annuity (with no refund on death), he can get a monthly payout of $929. This payout continues for as long as he lives, but there will be no refund on death.

He can get a bigger payout payable for a potentially longer period under a life annuity. This is possible because those who die earlier leave behind the balance of their money in the fund to pay to those who live longer. This is "pooling of longevity risk".

He can opt to buy an annuity that gives a refund on death during the first 20 years of the balance of 20 years payment. The monthly payout is $827, which is 11% less than the "no refund" annuity.

A female at age 65 can invest $150,000 in the following:

                                             
Payable for 20 years               $902   
Payable for 30 years               $709   
Payable for life - no refund       $747   
Payable for life - with refund     $728   

The payout under the life annuity is lower, as a female is expected to live longer than a male.

Disclaimer: These figures are based on an interest rate of 4% and the population mortality rates, with adjustment for future reduction in mortality. It ignores expenses and profit margin.

This is written to educate the public about the principles of life annuity. They may not reflect the commercial terms that may be offered by an annuity provider.

I used an interest rate of 4% to calcuate the annuity as it is the same interest rate paid by CPF on the retirement account. I hope that CPF can be convinced to offer a life annuity using the same interest rate. There is no additional cost to the CPF. This may make the life annuity to be more attractive.

Does an independent adviser give better value?

Someone frequently posted comments in my blog arguing that an independent financial adviser have a better range of products to offer to the client, compared to a tied agent.

In my view, this is not a priority. More importantly, it is the integrity of the adviser that counts.

Does the adviser (i.e. tied or independent) act ethically in looking after the best interest of the client? Or does the adviser push a product that earns the highest commission?

Within any company, there is a range of products. Some offer better value to the client and pays less commission to the adviser. Others pay higher commission. Which product does the adviser recommend?

When I was in charge of NTUC Income, I made sure that all the products offer good value to the customers, and a fair rate of commission to the agent. Most of the agents recommended these good value products, even today.

Purchase additional insurance

Dear Mr Tan,

I wish to seek your advise on whether I should take up a Limited Living Policy to which I need not pay any premiums after 20 years of retaining the policy. I still enjoy the protection and returns.

Currently I am holding a Foundation policy and a Pioneer policy from NTUC Income. I had this feeling that I was not insured enough so I contacted an agent who ecommended the Limited Living Policy.

I am now seeking your advice whether should I be going ahead with this policy.

MY REPLY:

Please read this FAQ.

In my view, it is better to buy term insurance and invest the difference in an investment fund, such as the combined fund of NTUC Income.

You can ask the adviser to show the difference in return under both options. You can make a more informed decision.

Write a will

I gave this suggestion to attendees at my educational talk.

1. Write a will. It will help your family to sort out your financial affairs when you pass away.

2. If you are not sure about your final intention, you can write an interim will now and replace it with a new will later, if your circumstances change. A will can be revoked by a new will.

3. If you do not write a will, it is all right. Usually, the family members will decide on how to distribute the assets through mutual agreement.

4. If there a dispute among the family members (without a will), the estate can be distributed according to the Law on Intestacy.

More importantly, an elderly parent should involve your family members early, in managing the assets, i.e investments and properties. This allows the family members to identify the assets and manage them easlily, following the death of the parent.

Distribute your assets early

I give this advice to attendees at my educational talk.

If a parent has more than sufficient assets for his or her future needs, the parent can distribute some of your assets to the family members early, rather than wait till the parent passes away.

This is how it can be done.

1. Assume a parent has $1 million of assets. Many middle income parents have this sum, inclusive of the value of a property.
2. Take $500,000 to buy a life annuity. It should give the parent more than sufficient for future needs.
3. Keep $150,000 in liquid form for emergency needs.
4. Distribute $350,000 to the children now (when they reach, say, 25 years)

The parent can vary the amounts according to the personal circumstances and the amount of the assets.

The advantages of this arrangement are:

1. No need to pay estate duty.
2. The money is more useful to the adult children now, rather than many years later (on death of the parent).

If the parent does not wish to give a lump sum to a child at 25, the parent can buy a fixed term annuity to pay the money over a period of say, 10 years.

Some attendees told me that they have not thought about this idea before, but they will like to consider it.

Reaching age 55

Dear Mr Tan

I will be reaching 55 years old this November. I was encouraged to buy into NTUC Income's annuity by a friend early this year.

However, with all these new govt policies coming out on the deferred bonus and interest rate on CPF, may I seek your advice whether I should still go for Income's annuity or not? I really appreciate your expert advice on this.

MY REPLY:

It is better to keep your money in the CPF retirement account to enjoy 4% plus 1%.

You can decide at a later date, when you are 62 years old, whether to invest in a life annuity from NTUC Income.

Coverage under Medishield and hospitalisation plan

Hi Mr Tan,

My husband is covered under the Government's Medishield plan. He is also covered under my company's hospitalisation plan for which I pay only 50% of the premium. Is this double insurance? Should I continue to insure him under my company's plan?

REPLY

There is double insurance for Medishield and the hospitalisation plan.

I suggest that you ask the insurer to explain to you the extent of the overlap. If the overlap is significant, there is no point for you to pay two premium. If the overlap is minor, then it is all right to keep the hospitalisation plan (as you only pay 50% of the premium).

You can see if the deductible under Medishield is covered adequately by the hospitalsiation plan.

Selecting a Shield plan

COMMENT POSTED IN MY BLOG

The situation is between the gap in Shield Plan for the Deductible and Co-insurance that is difficult to balance. The other scenario is one has employer benefit, and Shield Plan acts as a backup.

Shield Plan is a primary need. If one has not other coverage, look at covering the Deductible and Co-insurance. Insurers like Ntuc Income has Plus Rider that covers the Deductible and Co-insurance gap nicely.

Then again, some people do a low plan, example Plan Basic and seek private hospital care, then there will be a different scenario.

Some time it is difficult to decide on type of level of coverage unless one is sure which type of medical care one will need. Generally, most will be comfortable in B1 or B2 government restructured hospital care.

Most parents will prefer private hospital care for their young children. Some ladies, like privacy when come to woman's problem and sough private medical care.

Unless one is able to be firm on the need, some time overlapping cover may be useful in such situation.

But example if one has Plan Preferred with Rider, this will cover mostly all types of care, as this is private hospital level of plan.

Thomas Phua

Avoid over-lapping insurance policies

Take this example of a policyholder who has two medical insurance policies:

1. A Shield policy that pays 90% of the hospital bill in excess of $1,000.
2. A medical policy that pays 100% of the bill up to $5,000

The policyholder incurs a hospital bill for $8,000. The claimable amount is:

1. Shield policy: 90% of (8,000 - $1000) = $6,500
2. Medical policy: $5,000

The policyholder can only claim up to the bill of $8,000, i.e. $5,000 from the medical plan and $3,000 from the Shield plan. But, he had to pay a full premium for each policy.

It is better to avoid over-insurance through two over-lapping policies.

Pooling of risks

Insurance works on the principle of pooling of risks.

Take an example. There are 100,000 houses in a community. Each year, an average of 100 houses are totally destroyed by fire or other perils. The chance of a total loss is 1 in 1000 houses.

Each owner cannot take the risk of a total loss of his house. Suppose all the owners agree to participate in an insurance scheme, they only need to pay a pure premium of $1 to cover every $1,000 of the value of the property. A property worth $300,000 will need a premium of $300.

The insurance company will probably add a loading to the premium to cover the operating expenses and a profit margin, say $450. Each owner will probably find that it is worth paying a premium to cover the risk.

The insurance policy usually cover other losses as well, such as partial loss or damage caused by flood, burglary and other perils.

The insurance company will work out the total claims based on its past claim experience, and compute a premium rate for every $1,000 of insured value. A loading is added (for expenses and profit) to obtain the gross premium charged to the policyholder.

In practice, the risks are divided into separate groups according to the likelihood of a claim, to obtain the premium rate for each group.

Insure against big losses

You should buy insurance against a big loss with a small chance of occurence. Look at these two cases:

Case 1:
Potential loss is $100,000. Chance of occurence is 1%. Expected cost of claim is $1,000. Premium (allowing for expense and profit margin) is $1,500.

Case 2:
Potential loss is $2,000. Chance of occurence is 50%. Expected cost of claim is $1,000. Premium (allowing for expense and profit margin) is $1,500.

Analysis:

For case 1, you cannot afford to bear a loss of $100,000. So, it is worthwhile to pay a premium of $1,500 to cover this risk.

For case 2, you can afford a loss of $2,000. It is not worthwhile for you to pay a premium of $1,500 to cover this risk, as you have to pay $500 more than the expected cost of claim (of $1,000).

It is not necessary to take insurance against small losses. It is better to bear this risk on your own.

An example is the deductible under a Shield plan. It is not necessary for you to buy insurance for this deductible, as you can take this risk on your own (or pay out of Medisave savings).

People are living longer

Based on the mortality rates in 2005, the life expectancy at 65 is 17.7 years for males and 20.7 years for females.

Over the past 25 years, the mortality rates have been falling by an average of 3% yearly.

If this trend continues, and there is every reason to believe that it will, the life expectancy at 65 is expected to increase to 23.4 years for males and 27.5 years for females.

52% of males at 65 are expected to live to 85 years and 24% to 95 years. The proportion for females are 65% and 32% respectively.

        Based on death rates   Allow for decline in  
        in 2005                death rate, 3% yearly
         75yrs  85yrs  95yrs  75yrs  85yrs 95yrs

Male       77%   39%     7%     80%    52%   24%
Female     87%   53%    11%     88%    65%   32%

Note: The calculations are based on the mortality rates taken from the population, with projection for future improvement in mortality.

Funds with Low Upfront Charge

In America, you can invest in "no-load" funds. They do not have any upfront charge. 100% of your money is invested.

In Singapore, the usual upfront charge is 3% to 5%. Some unit trusts offer promotions that reduce the upfront charge to less than 2%.

I like to ask visitors to my blog to submit a comment. Are you aware of any unit trust that offer a upfront charge of 2% or lower? Give the following details: name of unit trust, distributor, website, upfront charge, expense ratio, size of fund.

Diversification and liquidity

Which will yield a better return over the next 20 years?

* STI ETF
* Genting International Shares
* Freehold private property

REPLY:

I prefer the STI ETF as it is well diversified (compared to an individual share) and has better liquidity (compared to a freehold property).

Retirement Planning

Dear Mr Tan,

I am in my early 50s and have $300,000 in my CPF ordinary account. What is your advice for my retirement planning?

REPLY

I suggest that you invest your CPF ordinary account in a large, well diversified, low cost investment fund.

You can select the following:

* STI ETF traded on the Singapore Exchange
* Combined fund from NTUC Income

As the stockmarket is at a high level, you should make this investment in lots over the next 12 months. Read this FAQ.