A 2024 Retirement Income Solution — Part 1
Key Takeaways
The recent changes in the CPF scheme highlights the government’s concern about the retirement adequacy of Singaporeans.
There are various ways to create an income from your investment assets outside of the CPF scheme.
Cash instruments, bonds, dividend stocks, and a total return income portfolio are some of the ways you can generate some form of return for the future.
We will show you why a total return income portfolio is the most sustainable way to create a long-term income from your investment portfolio.
The question isn’t at what age I want to retire, it’s at what income.
— George Foreman
The slew of CPF changes announced in the recent Singapore budget 2024 likely points to the Government’s concern about the retirement adequacy of the general population. While many of us would be looking at what cash handouts or rebates we would receive over the coming year, the changes in the CPF — which is meant as a form of social security to address retirement, medical, and housing needs — are small steps in helping Singaporeans ensure that they have some form of income to support themselves in their later years.
Amongst some of the CPF changes announced were;
Higher Central Provident Fund (CPF) contribution rates for those aged 55 to 65.
Raising the CPF Enhanced Retirement Sum (ERS) limit from S$319,000 to S$426,000.
Closure of the Special Account (CPF-SA) once you reach 55 years old and have your CPF Retirement Account set up.
A researcher from the Lee Kuan Yew School of Public Policy noted that the changes were overall positive. For instance, the higher contribution rates for older workers would enable one’s Retirement Account (CPF-RA) to be boosted by S$200 for every S$100 of wages earned over 10 years — considering the interest earned in the CPF-RA.
For those who are willing, and able to contribute to the CPF ERS, the new cap would help CPF members receive a monthly payout approximately 30% higher than the old one. Hopefully, this would help overcome the sharp rise in cost of living expenses.
However, the closure of the CPF-SA account when one turns 55 takes away an avenue for CPF members to earn a higher interest rate (currently 4.08%) on what would be a more liquid bucket of money as this would reside outside the CPF-RA and could be withdrawn.
But investors should not fret as there are various ways to structure sustainable, and long-term income generation from your investment assets which reside out of the CPF scheme.
Typically, when you think about how to generate an income, a few things come to mind. Most would think about these various assets — which pay a coupon or generate a dividend. These would be:
Higher yielding cash instruments such as fixed deposits, treasury-bills, and money market funds.
Government and/or corporate bonds.
Dividend stocks and REITs.
Total-return income portfolio.
Cash Instruments
At the present moment, deposit rates are at levels that we have not seen for a long time. Fixed deposit rates are approximately 3.5%, and T-bills at the latest auction are around 3.8%.
Money market funds provide a good alternative; similar to our Capital Holding Account, where a fund manager invests in some of these less liquid bills and bonds in a fund structure which provides daily liquidity. This way, you can hold for any duration you wish and still receive a pro-rated interest rate. The disadvantage of a money market fund will be the small fee that you need to pay the manager for doing all of this. However, current money market yields are approximately 4% after fees, so currently they are a really viable alternative to standard deposit accounts.
Disadvantages of deposit accounts are that if you require the liquidity and wish to sell before the stated tenure, you may not receive the interest, pro-rated or not.
In addition, over the long term cash barely provides you a return above inflation; see chart below. In many cases, it actually gives a negative real return (i.e. return after inflation). So while cash provides the benefit of liquidity, what you give up for this benefit is the lack of a long term sustainable return.
Government and/or Corporate Bonds
Bonds can generate income through fixed coupon payments and can potentially help stabilise a portfolio during a stock market downturn. However, many investors tend to focus only on yield when allocating to bonds instead of whether the company is able to return your money when the bond matures, or even how the allocation to fixed income is able to improve the risk management of your portfolio. As such, investors tend to allocate more to high-yield bonds and emerging market bonds as these instruments offer higher coupon rates than higher quality bonds.
The Vanguard study below shows how correlated high yield and emerging market bonds are to equities — with high yield having a 73% correlation and emerging market bonds having a 59% correlation. Having such a high level of correlation means that when equity markets are doing poorly and experiencing a large sell off, these bonds are also moving in the same direction and will suffer similar levels of loss as well.
Investing in high quality bonds does not mean that you are immune to a market downturn. In the example below, a 10-0 year Singapore Government Bond (one of very few countries with a AAA debt rating) underwent a -15% sell-off during the recent rate hike cycle and is still sitting -10% below its par value.
Source: Bondsupermart, GYC.
As such, while bonds can provide a stable cash flow from its coupon payouts, it is still subjected to market volatility. You have to take into account things like interest rate and duration risk when investing in them. In addition, what normally happens when you reach for yield is that you tend to experience more risk as these bonds end up acting like equity investments.
Another disadvantage of bonds is that there is no inflation protection on your investment. When the bond matures, you are returned your principal — the same amount that you put in when you first purchased the bond. So buying a 10-year bond in 2024 means that you receive back what you put in (excluding coupons) in 2034 — implying that your purchasing power returned to you is lagging by 10 years.
In our follow-up article, we will discuss the merits of allocating to dividend stocks & REITs, rounding of this series by showing how a total-return income approach to investing is one of the best options out there when considering how to create a consistent long-term income generating portfolio — especially for those who are at a ‘de-cumulation stage’ e.g. retirement.
For more information about our various payout and income generation strategies, come and speak to us.
