This is the fourth article of our retirement series. Throughout the past articles over the past months, we talked about how we helped our 59 years old retiree client, David, to have a reliable income stream in retirement using our proprietary tool called RetireWell. As a recap, David’s retirement objectives are:
- $10,000 per month for first 5 years
- Reduce to $8,000 per month for the next 10 years
- Finally, to $6,000 per month till age 83
At the end of age 83, he wants to have $1 million to leave behind for his loved ones or use it for himself if he lives longer.
Very briefly, based on what David wants, we allocated $1.479 million of his money, together with his rental income and proceeds from his insurance policies into various “buckets” shown in table 1. These “buckets” are really different portfolios with different risk and expected returns invested over different time horizon. (Do read the previous articles for a detailed explanation of the allocation)
Table 1: How RetireWell Optimizer Allocated David’s Resources
- From age 59 to age 83, David will receive a monthly income (adjusted for 3% inflation). A portion of it will come from the income bucket which provides the safe retirement income floor. The rest of it will come from drawing down from bucket 1.
- Bucket 1 will contain enough cash to drawdown for only 5 years. Once the cash is depleted, cash from the rest of the buckets will be transferred in, at the end of their investment period.
- At the end of age 83, all buckets (except income bucket and bucket 6) will be depleted. If David pass on at that time, bucket 6 will have an amount of $1 million to be left behind as legacy. If David lives on, monies in bucket 6 and income bucket will be drawn down to meet his needs.
The “buckets” or portfolios are invested as shown in table 2.
Table 2: How the various buckets are invested
The way the portfolios are invested is based on the principle that for portfolios with higher expected returns and risk, you need a longer time horizon. Our near 2 decades of investment experience also tells us that the best way to get these returns is to stay invested and not time the markets. As such we do not change these allocations in the short term to react to market news, like the recent Brexit and US Elections. These decisions have served our portfolios well.
In executing such a philosophy, we also need to find suitable instruments to execute it. In our previous article, I explained why we use Vanguard Index Funds. In this article, I will explain why we use funds from Dimensional Fund Advisors (DFA).
Previously, we showed that most active managers cannot beat the markets and for those that do, they cannot do it consistently. One reason is that many fund managers simply may not have the skill required to beat their benchmarks over the long run. Even if they do, because of the high fees they charge, it eats into the returns for investors and results in underperformance. Moreover, while there may be fund managers who may have the skill to beat their benchmarks consistently net of cost, identifying who they are is a challenge. As such, we prefer to use low cost index funds to do the job for our retiree clients. So why did we choose to use DFA then?
Not Really Active, Not Really Passive, But Evidence-Based Investing
The uniqueness of DFA is that they really straddle between actively managed funds and indexed funds. Like indexed funds, they are broadly diversified. One of their funds, the Global Core Equity Fund invest into about 6500 companies. Like indexed funds, they do not time the market because they believe that price is efficient and as such do not trade in and out frequently and thus incurring high cost. But like actively managed funds, DFA picks securities that give a higher expected return. The difference is that they only pick those that show evidences of a higher expected return that are persistent across time periods, pervasive across markets, sensible and cost-effective to capture. These evidences are based on academic research by scholars in the likes of Nobel Laureate Eugene Fama, Kenneth French and many others. Many of them act as academic consultants, board of directors or investment policy committee members to DFA.
It is one thing to be able to discover great investment ideas, it is another to be able to implement it effectively and efficiently while keeping cost low. DFA achieves it by firstly avoiding the need to buy and sell a security because of price targets. They keep the security as long as it continues meet their criteria and even if they need to buy or sell, because they invest in thousands of securities, they have choices and do not have to chase down any single security. And because of their size (they currently manage over USD400 billion), they have great economies of scale. On average, annual management fee for DFA funds is at 0.3% p.a., similar to an indexed fund. The average annual management fee for other equity-based unit trusts in Singapore is a whopping 1.65%.
But at the end of the day, it all boils down to performance. We chose DFA for our retiree clients because they have done well. Chart 1 showed the performance of one of the DFA funds since inception. It has consistently done better than the index over the long term and at a cost similar to an indexed fund.
Chart 1: Annualized return (%) of DFA Global Core Equity Fund (USD, ACC) as of 31 December 2016
Retirees face the following risks in the retirement phase of their lives:
- Longevity risk – the risk of money running out before you do
- Inflation risk – the risk of decreasing purchasing power
- Market risk -the risk of not having your money when you need it due to market volatility
- Withdrawal risk – the risk of overspending in your retirement years
But perhaps, the greatest risk retirees face is the risk of not having a second chance again. If their retirement monies are mismanaged, because of their age, the cessation of their earned income or even their poor health, they might not be able to accumulate a sufficient sum for their retirement again. While the RetireWell methodology mitigates all these risk via the bucket approach of financial planning, for it to work, we need to use appropriate financial instruments that are evidence-based, good performance track record and is sufficiently low cost enough to give retirees a reliable income stream.
The writer, Christopher Tan, is Chief Executive Officer of Providend, a Fee-only Retirement Financial Adviser. Besides being financially trained, he is also an Associate Certified Coach with the International Coach Federation. The edited version has been published in The Business Times on 4 March 2017.
Here are the links to the other 10 parts of the RetireWell® Series:
- Part 1: Drawing Down Retirement Money
- Part 2: Offering Retirees Security and Peace of Mind
- Part 3: Low Cost, Consistent Results
- Part 5: Investment Philosophy for a Retiree Client
- Part 6: Ensuring a ‘Safe Retirement Income Floor’
- Part 7: Remain Invested Over the Long Haul
- Part 8: Purpose-Driven Retirement Planning
- Part 9: A Tale of Two Retirees And Their Fortunes
- Part 10: Stock Markets Always Rise Over The Long Term
- Part 11: Retirement – It’s About The Kind Of Life You Want To Lead
If you are need professional help in reviewing your retirement plans, you can contact us at 6309 2488 or via https://www.providend.com/service-enquiry/.
We will give you our honest feedback regarding our ability to help you achieve your objectives and address the financial challenges you may be experiencing.