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Sunday, September 11, 2016

Four rules of thumb

Dr Larry Haverkamp
The Last Word

1. RULE OF 72.
How long does it take to double your money?
There is an easy way to get a quick and close-to-perfect answer. It is to use the formula (number of years) x (interest rate) = 72.

Let's say the interest rate is 4 per cent. Then how long will it take to double your money? (Answer: 72/4 = 18 years.)

Of course, you can do the same calculation to determine the interest rate you need for money to double. Example: If you will invest for 10 years. you need to earn 7.2 per cent interest (= 72/10) to see your money double.

People often wonder how to admit their portfolio as they get older. Most think. quite correctly, that you should accept a lower return and invest more cautiously as they age.

That is because if you invest in risky assets and lose money when you are old you will have less time to earn it back.

A good rule of thumb is your per cent of safe investments should equal your age.

For example, if you are 30 years old, you might hold 30 per cent of your assets in safe investments like your CPF accounts and fixed deposits. The other 70 per cent would go into risky investments like stocks. If you are 90 years old. you would put 90 per cent of your wealth in safe investments.

The hard part is figuring out which assets are safe and which are risky. How about your house? Is it safe or risky?

The answer is "safe". Since home prices appreciate over time, sharp price corrections are rare and it is an asset that most of us hold for the long run.

Another major asset is your CPF money. Is it safe or risky? It is super safe for each of your CPF accounts, which includes Ordinary, Special, Retirement and Medisave accounts.

What about whole life and endowment insurance policies? Those are also safe.

Finally, how about a car? That one is a bit of a surprise since it should not be considered safe or risky. Since it depreciates over 10 years. it is part of your consump-tion and not an investment.

The retirement age is 62 and you probably know someone who is retired. Of course, you will retire someday too. It is helpful for retirees to know how quickly they can draw down their savings once they stop working.

A common rule of thumb is to spend 4 per cent of your assets every year. At that rate, your assets will last another 25 years even if you earn zero per cent interest. Of course, they will probably last longer since you will probably earn a little interest, at least.

How about your retirement and other CPF accounts? Are those part of your assets? Yes. And you should also count your CPF Life payouts as part of the 4 per cent drawdown.

For example, if you retire with $1 million in assets (including CPF) then your 4 per cent drawdown comes to 540,000 per year, which is $3,333 per month.

If you receive $1,000 per month from CPF Life, the 4 per cent rule says you should take $2,333 from your other savings for monthly living costs.

One more question: Should you include your home as one of your assets?

It is an important question and the answer is usually "No". That is because most people don't sell their home after they retire, so they wouldn't use it to fund their retirement.

Keep in mind that if your mortgage is fully paid by the time you retire - which it usually is - then it won't cut into your monthly income like it did in your working years. Eliminating this major expense makes it easier to live on a lower retirement income.

For most of us, the biggest debt is our home loan. Next are car loans. After that are our personal loans, credit card debt, renovation loans and even pawnshop loans.

How much should you borrow from each?

A big part of that question has been answered for you with new housing rules concerning your Mortgage Servicing Ratio (MSR) and the Total Debt Servicing Ratio (TDSR). The MSR limits your home loan to 30 per cent of gross income and TDSR limits total debt to 60 per cent of gross income.

For example. the MSR rule is that monthly home loan payments divided by gross income cannot exceed 30 per cent. Gross income includes your own CPF contribution but not your employer's.

TDSR is monthly loan payments for all debt divided by your gross income. When you purchase a flat, your new home loan cannot push your MSR and TDSR above the limits.

The purpose is to prevent home buyers from over-leveraging as well as to keep home prices affordable.

By the way, the TDSR max of 60 per cent applies only to home loans. If a car loan, for example, pushes your TDSR over 60 per cent, it will not affect your ability to take a car loan.

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