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Sunday, May 18, 2014

If in doubt, sell half

The Sunday Times
Goh Eng Yeow

As a financial writer, I regularly get queries from readers about their investment strategies but while they might sound innocuous, they often defy straight-forward answers.

Take this from Mr Lawrence Law, a 58-year old Singaporean working in Jakarta who got into share investing only late in life.

Mr Law bought 2,000 Singapore Airlines shares in two tranches but the average cost was below the carrier's market price. He asked if he should sell the 1,000 shares that were profitable, while keeping the other 1,000 that were still below his investment costs.

Well, the answer will depend on what sort of investor he is.

If he is a "buy and hold" person like me, he will probably not do anything as he would have studied the counter very carefully before investing and would settle in for the long haul.

This is the approach so elegantly elucidated by investment guru Benjamin Graham, who noted that in the short run, the market behaves like a voting machine - tallying up which firms are popular and unpopular. But in the long run, it is a weighing machine, assessing whether a company's business has substance.

But herein lies the problem: There are times when a company is unloved, for whatever reason, even though it enjoys good business fundamentals. This is reflected by its depressed share price.

It may take a long time before it is priced correctly, yet in the meantime, it can be frustrating and painful for investors who are right about the company at the wrong time.

One example is beverage giant Fraser & Neave, whose share price had traded for years at a so-called "conglomerate" discount to the value of all its various businesses when they were added up.
The shares finally received a boost nearly two years ago when it became the subject of a fierce takeover tussle that resulted in Thai billionaire Charoen Sirivadhanabhakdi taking control.
So for many investors, it may be the tallying of votes - what other people think of the stock - that matters a lot more than the weighing machine Mr Graham talked about.

There is another analogy for investors who take a much shorter view on their investments, one enunciated by another great investor, the British economist John Maynard Keynes.

He described investment as a beauty contest with a difference. To guess the winner, what is important is not to select who you believe to be the most beautiful contestant but to guess at how the judges will rate the various contestants.

Seen in that light, successful investing is really a lot more psychology than anything else, a process of coming to grips with your own emotions as well as others'.

My answer to any investor, who is confronted with a dilemma over taking profit on his winning bet or cutting loss on a plunging stock, is to sell half of it.

Selling half of the investment will release the psychological logjam that comes from trying to decide whether to keep the investment or get rid of it completely. He can then analyse why he bought the stock in the first place, and whether to hold the remaining shares, sell them or buy more.

This ploy is especially useful to a trader who is facing losses on his bets. What should he do if he keeps losing money even though he believes he is right and that the market would see sense eventually?

When a stock falls substantially, the trader's first reaction is denial, as he hopes to salvage the best of a bad situation, telling himself that it is only a short-term fall.

Then when it drops further, he may start calculating how much money he has lost. He may even hold the stock for a while longer, and then when it hits bottom, sell everything and swear never to invest in shares again.

But selling half of the investment first saves him from an even bigger loss if the price continues to plunge. But he will also be able to enjoy some of the investment's upside if the price recovers.

Once a trader has crystallised his loss, the next step is to look ahead and not dwell on the past, wallowing in despair over how awful it must feel to throw such a huge wad of money down the drain.

Let's face it, no matter how successful we are as investors, all of us have encountered disasters at one time or another. In his latest newsletter to shareholders of his company, Berkshire Hathaway, investment legend Warren Buffett owned up to losing a whopping US$873 million ($1.1 billion) on the debts issued by a firm known as Energy Future Holdings.

"Most of you have never heard of Energy Future Holdings. Consider yourself lucky; I certainly wish I hadn't... Unless natural gas prices soar, EFH will almost certainly file for bankruptcy in 2014," he wrote.

The rest of us would not have $1 billion to lose in the first place. But in acknowledging his investment mistakes, Mr Buffett flags the importance of learning from them and moving on. That is a valuable lesson for all of us.

Background story

Dilemma solved
Selling half of the investment will release the psychological logjam that comes from trying to decide whether to keep the investment or get rid of it completely. The investor can then analyse why he bought the stock in the first place, and whether to hold the remaining shares, sell them or buy more.

Wednesday, May 14, 2014

Planning for a sustainable retirement

The Business Times
Lorna Tan

BUYING an annuity insurance policy is a daunting experience.

That was how I felt when I forked out $100,000 to insurance cooperative NTUC Income in 2011 in return for some peace of mind in my golden years.

It was unnerving not only because I coughed up a six-figure sum as a one-time single premium. It was daunting because, knowing that I'm here on earth on borrowed time, I felt as if I was audaciously negotiating with my maker for a longer life.

After all, it makes sense to buy an annuity only if I believe that I can live (God willing), and am committed to living, a long healthy life.

In 2011, I bought NTUC Income's Guaranteed Life Annuity policy, which is expected to pay a regular guaranteed income - $700 per month or $8,685 per year - from the time I turn 65 till I die.
So the longer I live, the more payouts I get to enjoy from the insurance policy.

But what happens if my "longevity" plan fails?

The policy comes with a death benefit that will be paid to my beneficiaries in one lump sum.
There are two scenarios. If death were to occur before I turn 65, the higher of the single premium or 97 per cent of the premium accumulated with interest and bonuses, is paid.

If death were to occur after the annuity payouts have started, the premium with interest and bonuses accumulated from the time I purchased the policy till my death, less the total annuity payments made, would be refunded.

The interest rate is guaranteed at 2.5 per cent per annum. And what if I change my mind and wish to surrender the policy? I could do so but it is not advisable as buying a life insurance policy, particularly an annuity, is a long-term commitment and an early termination involves high costs.

I would incur a loss if the surrender value is less than the premium paid. I can only "win" from buying the Guaranteed Life Annuity plan if I live a long life.

At least, until I live past 90, which is when I "break even". On a 2.5 per cent interest rate, it takes roughly 25 years for me to recoup, through the annuity payouts, my original $100,000 single premium, which would have compounded to $160,000 by the time I reach my drawdown age of 65.
Some of you may wonder why I bought an annuity.

After all, this would be on top of another annuity plan, the compulsory national annuity scheme called CPF LIFE (Lifelong Income For the Elderly), which Singaporeans or permanent residents born in 1958 or after would be placed on, when they reach 55. Under this scheme, members receive a monthly income for life, starting from their drawdown age.

If you are now a 50-year old male and have the CPF Minimum Sum of $148,000, your default CPF LIFE monthly payout from age 65 would be from $1,157 to $1,283. (The CPF Minimum Sum will be raised to $155,000 from July.)

Women are expected to live longer lives (87 for females, 83 for men) so the payouts based on the current Minimum Sum are lower, projected to be $1,053 to $1,172.

Well, the decision came about after I did an about-turn in my retirement planning.

Like many people in the past, I used to think that retirement planning is all about accumulating a certain magic number - depending on your desired lifestyle - before the drawdown phase kicks in. Not anymore.

As life expectancies increase, thanks to a host of reasons such as advanced medical science, one retirement risk we potentially face is the danger of outliving our nest egg.

It has been reported that for Singaporeans who are 65 today, about half of them are expected to live another 20 years (that is, 85 and beyond), while a third will live beyond 90. Therefore the difficulty of determining this magic retirement sum increases as well, rendering such an approach unsustainable. How much of this lump sum is enough? What if we get our sums wrong?

I used to think I would have achieved financial independence and could call it a day at work when I reach my retirement target of a million dollars.

I was wrong. Faced with a longer life expectancy, the rising cost of living, ongoing support for my ageing parents and an estimated overseas education bill of about $500,000 to be chalked up by my two kids in the coming years, I had to redo my sums.

To mitigate this risk, I've shifted my focus to ensuring lifelong cash flows or income sources - which we can call an income goal - that would fund my golden years, instead of just achieving a certain magic number.

Having an income (better still, if it is inflation-protected) throughout my golden years is now a measure of my success in retirement planning.

This income goal has a few important characteristics:
•The cash flows should be regular and sustainable.
•They should generate enough income for me to live on at all times, whether the economy is up or down.

A good way to get started is to work out the cash flows you need, followed by the crucial step of matching the investments that will generate income sources to fund the desired cash flows.
To make it easy to work out my cash flow needs, I pictured a money pyramid, much like a food pyramid, with the basic subsistence category of needs at the bottom.

Here, I would include essentials, such as food, housing, medical, insurance, utilities, and allowance to parents. It is prudent to project realistically how much you would need (say, $3,500) to sustain these retirement essentials. And I would want to ensure that the income flows required to fund these needs are safe, predictable and guaranteed.

Begin by listing the regular, sustainable and guaranteed recurring income flows (say, $1,500) that you already have and work out the cash flow gap ($2,000), before deciding how this gap could be closed.
This is where the two annuities I own would come in handy as they would potentially provide two streams of "guaranteed" income flows totalling about $1,700 per month.

Other financial instruments that would qualify are bank savings, monies and investments parked in my Supplementary Retirement Scheme account, dividend payments from real estate investment trusts (Reits), coupon payouts from bonds and preferred stocks, and rental income from investment properties.

The next layer in the money pyramid is the category of wants or non-essential items that I could do without if I couldn't afford them, such as cable TV, dining out, shopping, gifts, leisure activities and vacations. The income flows channelled to satisfy these wants would be generated by investments that offer growth and capital appreciation, and may be volatile. Examples are stocks, unit trusts, commodities and hedge funds.

In summary, they would be relatively less safe, less predictable and less guaranteed compared with the investments you match with the cash flows of your essential needs.

The rationale is that as I have taken care of my essentials, I can take more risk with the remainder of my retirement savings. Of course, this would also depend on your risk appetite and capacity. It is easy to fall into the mistake of matching the wrong investments with the different categories of cash flows. For instance, I wouldn't expect my investments in single stocks to fund my essential needs.

Here's why:

Taking a pointer from the financial meltdown in 2008 when stock prices headed south, many retirees who primarily invested in stocks found themselves caught in a situation where they either got out of the stock market with huge losses or gritted their teeth and tried to stay invested for better days.

When their stock investments were unable to immediately generate the cash flows they needed, they faced the dire choices of either going back to work and/or cutting down their expenses drastically.

In a best-case scenario, if I could successfully achieve my income goal, I could live off that income during my lifetime and bequeath my principal savings and assets to my beneficiaries.

Now, that would be planning my retirement sustainably.

The writer is the author of 'More Talk Money' and 'Talk Money', and former Sunday Times Invest editor. She is senior vice-president, corporate communications, at CapitaLand