Making your money work harder for you has been relatively challenging ever since the Global Financial Crisis began in 2008, with later events such as the European debt crisis and China’s economic slowdown creating so much volatility and uncertainty in equity markets that many retail investors have found it hard to stay invested and, ultimately, to make decent returns.
Investing returns are likely to be much lower in the years ahead
The McKinsey Global Institute (MGI), which was recently ranked by the Lauder Institute at the University of Pennsylvania as the world’s number-one private-sector think tank, released a report this month suggesting that while US and European equities averaged 7.9%p.a. real returns over the past 30 years, they may only deliver 4.0-6.5%p.a. and 4.5-6%p.a. real returns respectively over the next 20 years. The prediction for bonds is direr: US and European bonds averaged 5.0%p.a. and 5.9%p.a. real returns over the past 30 years, but are forecasted to deliver real returns of 0.0-2.0%p.a. over the next 20 years. Real returns have been adjusted for inflation.
There are several reasons for their gloomy outlook: slowing global growth, declining corporate profits, low-interest rates, and low inflation.
In the last 30 years, global GDP growth has been strong mainly due to productivity gains, increased employment, positive demographics and revenue growth from new markets such as China. These reasons, however, no longer apply to the current global economy. Productivity has slowed, unemployment rates are now relatively low, populations are aging, and the slowdown in China’s economy has had a knock-on effect on the rest of the economies which have grown dependent on it for growth, particularly in Asia. Singapore is facing the same challenges – while GDP growth from 1976-2015 averaged 6.8%p.a., the latest forecasts are for Singapore’s GDP to only grow by 1.9% for 2016.
Strong competition from emerging market countries have led to declining corporate profits from developed countries. For example, the offshore and marine sector in Singapore has had to cut its margins to compete with Chinese companies offering similar services at lower prices. Advancements in technology have also disrupted traditional markets. In the retail space, online shopping websites such as TaoBao.com, qoo10.sg have also increasingly taken market share from shoppers who are happy to browse at the malls but make their purchases online to save costs.
While inflation was as high as above 10% in many countries in the early 1980s, many countries today have inflation rates below 2%, with central banks doing their utmost to stave off deflation by lowering interest rates to 0%, and in the case of Japan and some European countries, even venturing into negative interest rate territory. Equities and bonds enjoyed higher returns as inflation and interest rates fell, but even as the debate on the benefits of negative interest rates continues, it looks unlikely that they will go much lower from here. If they were to go up in future, returns from equities and bonds are more likely to decrease. The yields from newly issued bonds in Japan have fallen to the point that pension funds have had to reduce their bond allocations and increase investments into equities in a bid to obtain better yields, even though equities come with higher risk. In Singapore, our life insurance policies, endowment plans, and retirement-income annuity-like insurance policies all have one thing in common: projected returns (they currently range between 3.25% to 4.75%p.a. for their respective portfolios). A portion of these returns will then form a part of the policyholder’s retirement nest egg. The asset allocations of such funds tend to be relatively conservative so as to preserve capital; for example, NTUC’s Life Participating Fund’s asset allocation for 2015 was 67% Bonds, 24% Equities, 3% Loans, 4% Properties and 2% Cash/Others. However, in order to obtain better yields to match the projected returns they had previously forecasted to clients, they may need to rebalance their allocation toward riskier, alternative assets, which may or may not give them the returns they are looking for either. If the fund decides to maintain its bond-heavy asset allocation, it is possible that its actual returns will be lower than initially projected.
What do lower returns on our investments mean for those of us who are planning for our retirement and for our children’s education?
Here are 4 things we need to do
- Construct/re-evaluate your financial plan. Constructing a financial plan would include determining the age you would like to be able to retire at, planning for the lifestyle you wish to enjoy upon retirement, and managing your savings and expenditure so as to build the necessary nest egg upon retirement. With lower expected investment returns compared to in the past, you will need to save more or work longer in order to enjoy the same retirement lifestyle. A proper financial plan would be able to tell you how much you need to save so that it becomes a tangible goal that you can identify with. If you are not familiar with or confident about constructing a proper financial plan on your own, engage a professional financial advisor whom you can trust and, preferably, who has no conflict of interest with you. If you have already constructed a financial plan, you may wish to re-evaluate the assumptions which had been previously made regarding the expected long term returns on equities and bonds and adjust them and your plans accordingly.
- Invest in better portfolios. By better portfolios, I mean low-cost, diversified portfolios which will give you the highest probability of achieving the highest returns on a risk-adjusted basis. Cost is one of the few things that we can control in our investments (along with our emotions, some might say, although this is highly debatable), and it is also one of the main reasons as to why so many investors underperform the market. If you go with low-cost investments, you have a significant part of the battle won. Additionally, too many investors treat investing like a game or a gamble and seek the highest returns while paying no attention to risk at all. As a result, they tend to be inadequately diversified, and a few losers in the portfolio can severely impact the performance of the portfolio as a whole. Unfortunately, very often, due to improper accounting, many are not even aware of how their portfolios have really performed. Choose low-cost, well-diversified portfolios that fit your risk profile and your needs.
- Understand how your CPF accounts work. One of the easiest ways to make your money work harder for you – and by easiest, I mean risk-free, no commissions or fees, and very decent returns – is to put it into your CPF. The current risk-free interest rate of up to 3.5% in the CPF Ordinary Account which compounds yearly is remarkable when you consider how low fixed-deposit interest rates have been since 2008, especially as the funds in the Ordinary Account are available for you to use when you wish to purchase a property, pay for your housing loan monthly instalments, or if you simply decide to invest them on your own. The current risk-free interest rate of up to 5%p.a. in the CPF Special Account and Retirement Account which compounds yearly is probably near impossible to obtain anywhere else, especially when one considers that yields from equities and bonds are likely to become even lower in the future. The above interest rates include an extra 1% interest paid on the first $60,000 of a CPF member’s combined Ordinary and Special account balances (with up to $20,000 in the Ordinary Account). Make use of your CPF accounts to earn better yields for you, while understanding the liquidity restrictions which are in place. You could think of them as the low risk/bond component of your portfolio as you will not find better risk-free SGD interest rates anywhere else. (For reference, a 30-year SGD Singapore Government Bond currently yields 2.56%p.a.)
- Understand how CPF LIFE works. Any financial advisor worth his salt and who has your interests at heart will advise you to take advantage of the retirement scheme which is CPF LIFE. There is no better annuity plan in the market which will pay you a guaranteed, risk-free, 4%p.a. on your Retirement Account funds and distribute a monthly income to you for the rest of your life. It should be the cornerstone of your retirement plan. Watch this video to learn you can integrate CPF LIFE as part of your retirement plan: https://www.providend.com/retirement-planning-part-2-understanding-cpf-life/
Some final thoughts
In my interactions with investors, friends and family (including my wife who is simply relieved that I understand it), I have found that many do not actually understand how their CPF accounts and CPF LIFE work. Frankly, this is not very surprising to me, as it does take some effort to understand them. However, I believe that in a low-interest rate, low inflation, and low yield environment, taking the time to understand and thereby maximize the risk-free interest rates from CPF and CPF LIFE will enable you to retire much more comfortably than if you did not.
You should also re-evaluate your current investment portfolios, paying particular attention to your costs, and see if you can make them more efficient. If returns are going to be lower in the future, all the more you need to try to reduce your costs – after compounding, it can make a tremendous difference to your nest egg in the long run. Finally, if investment returns are indeed going to fall, then saving more today will help to ensure that you have enough to spend tomorrow. If future investment returns turn out to be higher than projected, it simply means that you will have a larger buffer for your retirement needs.
This is an original article written by Sean Cheng, Solutions & Investments Executive at Providend, Singapore’s Fee-only Retirement Financial Adviser. The edited version appeared in Business Times on 14th May 2016.
 McKinsey Global Institute, “Diminishing Returns: Why Investors May Need to Lower Their Expectations,” May, 2016.
 Source: Singapore Department of Statistics
 Kelly Tay, “Economists again cut forecast for Singapore’s 2016 GDP growth”, The Business Times, March 17, 2016, http://www.businesstimes.com.sg/government-economy/economists-again-cut-forecast-for-singapores-2016-gdp-growth.
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