Sunday, September 27, 2015

Manage your CPF well but please do not rely on it !

I'm very busy this week as I have my mid-terms and a presentation to make next week in school.

Nevertheless I want to elaborate on this point I made in my radio interview which Driz'zt of Investment Moats has kindly referred some traffic to me is his very well-thought article on CPF.

We Singaporeans are a lucky lot because a large part of what our government do actually works. The same cannot be said if you happen to live in our neighbouring countries.

The mindset of not relying on CPF is not a judgment on our government's capabilities. I am a lot more positive than Driz'zt and Roy Ngerng and believe that a comfortable lump sum awaits me at age 55. I expect to get a nice lower 6-digit sum at 55, which translates to about $1,000 a month additional passive income after that. It's not enough to live on if I have yet to clear my mortgage loan, but it's a nice welcome addition to what I already have. So the primary effect of relying on ourselves allows us to achieve a more comfortable retirement when the CPF board suddenly decides to reward us when we reach 55 years old.

That being said here are some minor points to push the debate further.

a) I am a strong proponent of the CPF-SA transfer.

I see real estate being stagnant for the next decade with interest rates rising, so the option of using the CPF-SA to get a bigger home may not be such a good idea. I prefer small homes with a larger investment portfolio and performing the transfer earlier in your 20s will see more interest being credited over your lives. More interest from CPF-SA makes it earlier to cross the minimum sum hurdle so you get all of it back after you hit 55.

Sometimes not having options when it comes to money is not such a bad thing. I might be considered foolish or insane when I maxed out my CPF-SA in my twenties because I did not know who my wife will be in those days. I thought Gen-X Singapore women would want bigger houses and would deplete my CPF resources so I decided to keep it out of reach from my future wife before I even met her. I still managed to get my EC in the end and the government credits over $6k to my CPF-SA every year as a result of that action.

( I reserve the right to change my mind if the Government raises the amount we can invest in our CPF-SA. Ideally, I would like to invest 100% of my CPF-OA but not everyone would well if this opportunity arises. )

b) CPF Life is better than the alternatives from buying it from commissioned agents. 

A retiree's passive income is best supplemented by an annuity. The problem is that annuities are expensive and affect the rights of your remainder men.  CPF Life solves the problem for us because we can just rely on it to fend off mortality risk. From the point of view of a million dollar portfolio, the government is not retaining much of your assets and another guaranteed $1500 passive income from age 65 is not a bad idea.

The broad idea is to have a portfolio of securities to provide capital gains and dividends supplemented by a fixed annuity payment. You eat your annuity payments first and farm remaining dividends back to your portfolio to keep the engine moving. If my portfolio remains large relative to the sum retained by CPF, I can opt for bigger monthly payments with less money returned to my family when I die.

c) Max out your CPF-IS with high-yielding blue chip stocks.

Finally, if possible max out the CPF-IS scheme and do it before you buy your first property because the government will not force you to sell your holdings if it exceeds 35% of your CPF-OA.

I also manage my CPF-IS differently from the rest of my portfolio.

As I can't extract dividends from this portfolio, I choose big bluechip companies that I can afford to hold for a long time horizon which yields higher than the CPF-SA rate. This guarantees that for some market risk, I get to have bigger returns than the default 2.5% that the CPF Board gives me.

In conclusion, while we should not rely on the CPF for our retirement, managing the CPF well can give you a $1,000-$2,000 boost to your monthly passive income after age 65. While the CPF-SA is not as flexible as the CPF-OA, it comes with a gigantic boost in guaranteed returns so transferring the OA to SA in your mid-twenties is not a trivial strategy.

Saturday, September 19, 2015

Peer to peer lending strategy using the Kelly Criterion.

There is very little literature on how to invest in peer-to-peer lending campaigns and I am pretty sure that very few financial bloggers who have a decent framework on peer-to-peer lending.

I am going to attempt to come up with a blueprint on how to size your bets when you are being offered a campaign on any lending platform.

This approach is based on the Kelly formula which is employed by gamblers in casinos. It is an optimization strategy which maximises long term returns. Based on what I know about the current state of lending platforms, the Moolahsense platform has enough data to facilitate this form of bet sizing.

I would leave the mathematical proof of this approach to the experts.

[ For the purposes of this article, this article only applies to lending projects and does not apply to equity crowdfunding campaigns. As I have a fairly personal bias against property crowdfunding, I do not advise that this be applied to property projects at all but some folks ]

Let's say you have a campaign and have allocated $10,000 into peer to peer lending which forms your bank-roll.

Scenario 1 : Attractive Campaign

This sample company will pay-back a total of $1060 in one year. Suppose you check the company data and find that the calculated default probability is 2.5% over a year.

The Kelly criterion which recommends that you bet proportion x of your total bank roll where

x = ( Expected net gains ) / ( Gains on successful campaign )

Start with an assumption that your position is $1000.

You can earn at $60 on a successful campaign. When the company defaults, you expect to lose everything or all of $1,000.

Expected net gains
= Earnings x Probability of success
= [Earnings x Probability of Success - Loss x Probability of Failure]
=  $60 ( 100% - 2.5% ) - $1000 x (2.5% )
= $33.50

Gains on a successful campaign
= Best case scenario
= $60

x = ( Expected net gains ) / ( Gains on successful campaign )
   = $33.50 / $60 = 55.83%

In the above example, the recommendation would be to bet about $5,000 or $6,000 into this campaign as it is fairly attractive.

Scenario 2 : Campaigns to avoid

Let's consider a campaign which returns $1,090 in six months but the website says that there is more than a 16% chance of default within a year which you estimate should turn out to be about 20% a year.

Return is $90 on a successful campaign. You lose everything in the event of a default.

As it is a six month campaign, you should be using a default rate is (100%-20%) ^ (6 months / 12 months) or 10.56% or just about 10%.

Expected net gains
= Earnings x Probability of success
= [Earnings x Probability of Success - Loss x Probability of Failure]
= $90 x 90% - $1,000 x 10%
= -$19

Once you get a negative number, you should avoid this campaign and look for something else to do with your money.

Scenario 3 : Risky campaign where you can ask for more

If you can offer more for Scenario 2, what happens ?

Suppose you can choose to offer a high rate which returns $1,120 in six months.

Return is $120 and you lose everything in the event of a default.

As it is a six month campaign, you should still be using a default rate is 1- [(100%-20%) ^ (6 months / 12 months)] or 10.56% or just about 10%.

Expected net gains
= Earnings x Probability of success
= [Earnings x Probability of Success - Loss x Probability of Failure]
= $120 x 90% - 1000 x 10%
= $8

x = $8 / $90 = 8.88% which you can round up to 10%

For this campaign, you should bet a smaller amount - no more than 10% of your total bankroll.

You should therefore bet the minimum of $1,000 of your bankroll is $10,000.

This framework should be a superior but riskier approach to something which I am currently doing, which is to bet the minimum amount of $1,000 across as many campaigns which I can get my hands on.

If you wish to follow my strategy which maximises diversification, you should still employ the Kelly formula to find out which campaigns to avoid. At the very least, you should choose the minimum amount of return such that your expected net gains are a positive number.

I think this is cutting edge stuff, so comments from seasoned traders are welcome !

Wednesday, September 16, 2015

Notes from my last interview at Kiss 92 FM on retirement.

I think I was a lot more nervous in this round of the interviews because some of the questions veered away from what I was prepared for, apologies if there are more time fillers if you are a Toastmaster.

Nevertheless, it was a good session.

I want to clarify some points I made and highlight some questions I addressed when I was off-line with the deejays,

a) REITs are not everything.

The DJ's couched the questions from the position of a rent collector which was how the conversation veered towards a discussion on REITs. While REITs are a mainstay in my investment portfolio, I rely on four asset classes to build my passive income. ( Four clases are REITs, Business Trusts, High yielding equities, Peer to peer lending. )

I hope that this does not trigger a bull run on REITs as we have no idea how they would perform in a high interest rate environment.

b) What REITs to buy ?

Offline the DJs wanted to know which REIT to buy. I was trying to evade the question so as not be construed as advising someone financially. I answered that if a person buys all the REITs in a diversified REIT portfolio it is possible to achieve 7% yields right now so individual stock selection is not necessary in the current climate.

c) Question on CPF.

This question was entirely ad-hoc and I would not want to offend any authorities listening to the program but I stand by my advice that if you need to rely on your CPF, you are not ready for retirement. CPF life gives a great boost of about $700 - $1900 a month after you reach 65. I expect many Singaporeans would not be able to hold jobs between 55 and 65 so they will need personal savings to tide over that decade.

d) Books to read.

Well meaning friends ask me why I did not recommend my own books. The reason is that Growing Your Tree of Prosperity is almost sold out. Other than George Clason's Richest Man in Babylon, my book Sowing the Seeds of Prosperity is designed to get the local investor started.

Every serious investor needs to get to the point where he can understand The Intelligent Investor by Benjamin Graham.

e) With-holding cash from children to promote good money habits/

Maddy really threw me off-guard with a question on whether it is wise for parents to withhold money from kids and put it in an account for them to witness compounding growth in action. Maddy suggested 10%. I was doubtful because I was not sure whether kids would be deprived from this form of parenting and whether this strategy would backfire so I suggested that she be moderate with this program.

An answer to this question would be complicated and reduces to a question of how to instill conscientiousness and willpower in children. At least from the child development literature I know, there are no solid answers.

One thing I know : You want conscientious kids, make babies with a conscientious spouse.

( Three hours in family court every week also confirms this ugly truth )

It does not help that I was a spoilt only-child who can have almost every toy I wanted as a kid but grew up to be an adult who really needed nothing much other than to read, solve complex problems, play D&D and troll my law school classmates,

f) Opinion on SPH.

Maddy also triggered a very interesting discussion on SPH and asked me my opinion on high-yielding counters with declining businesses. My view is that a long term buy and hold investor of SPH is not so badly off as he would have collected substantial dividends and would now have some SPH Reits in his portfolio as well.

Dividends investing is quite anti-fragile. Time heals all investment mistakes.

g) Singapore Savers Bonds 

There was some small-talk on SSBs. I did not buy any but I am glad that the government has created a product which people are talking about in a positive way.

I am still pining for my inflation protected bonds.

Anyway my notes going into Kiss 92 is as follows :

When is a good age to retire?

This answer varies from individual to individual. A person who wishes to retire would need to accumulate enough assets such that it would be enough to last them the rest of their lives. This is a difficult problem because we do not know when we will die and have no idea what our spending patterns are like post-retirement.

Is 55 too late to start planning for a 'retirement life'?

Again it depends. It is easier to retire if you are single and have no dependents. A late planner may have sufficient income to start accumulating a portfolio which can be used to supplement the income from CPF life which kicks in at age 65. So it's entirely possible to start saving from 55 until 65, and then rely on investment income and income from CPF to retire from the workforce.What are some things we should consider when we plan to retire?

When should we start planning our retirement savings?

The best time to start planning is before graduation immediately after your last set of final exams. The savings accumulated in your 20s would subject to the most amount of compounding throughout your life. So learning about savings and investments are crucial before your first pay-check. Accumulating knowledge is also easier in your 20s. As for me, I studied finance at the professional level once I exhausted all the usual investment books so I went after the credentials which most private bankers have.

When should we start saving for retirement?

The easiest approach is to start from your first pay-check. At 7% gains, you will need to save $820  a month if you give yourself 30 years to become a millionaire. If you have twenty years left, you will need $1920. If you only have 10 years you will need $5780. So it gets progressively harder as you get older to save for retirement.

How much is enough to retire in Singapore?

Two factors determine how much is enough for retirement. The first is how well you can manage your investments post retirement. The second is how much you will need to spend post-retirement. For a single man who is a good investor who can find investments which can yield 8% a year and spends $2,000 a month, he can be financially independent with a portfolio size $300,000. However, it would be prudent to build a margin of safety around that figure of $100,000 and find a part-time job which gives personal satisfaction if you are in such a person's shoes.

How should we retire?

Cautiously. Getting a retirement income to supplement your expenses is not enough. I was bored for the first 6 months after I left the work force and before I got accepted into Law School. A retiree needs to be mentally engaged. The other consideration is that friends in the same age bracket are likely to be still at work and struggling with mortgages.

Socially, it's quite hard for society to accept a 39 year old male who has left the workforce. Many SIngaporeans do not think that it is possible and many thought I relied on my wife for her income before they found out that she's actually a housewife.

Based on surveys, retirees typically spend less on food and transport but more on medical expenses.

When can we retire?

Based on surveys, Singaporean prefer to retire at 55.

I prefer the listener to consider financial independence as a better goal than retirement. Financial independence occurs when your investment income : rentals, dividends, patent and royalty payments exceed your regular expenses. Then you carry on working until you get a comfortable safety margin beyond your regular expenses. Then you should consider retirement.

Do we only start saving for retirement when we have a stable income?

If you wait for a stable income, it would be too late. If you income is unstable, you would need to spend below the lowest estimate of your monthly salary and put your savings in your investment portfolio. If you are unable to save, you would struggle because life throws many curve-balls at you - someone can fall sick and you might have unplanned expenses. 

Tuesday, September 15, 2015

My next radio interview is tomorrow Wednesday, 16 Sep 2015 8am, at Kiss 92 FM.

Looks like I was able to secure another radio interview with Kiss 92 FM at 8am tomorrow.

The topic : "What is the best time to retire ? "

Keep reading this blog as I will post some of my research notes after the interview so that we can have a deeper discussion here.

Wednesday, September 09, 2015

Write your own manifesto ! Rekindle the Singapore Dream !

The concept of a manifesto has become more interesting in the upcoming elections.

For a party which is not likely to form a government, a manifesto is of little use to the electorate but serves a purpose similar to that of marketing collateral. You see that these parties would come up with the best manifestos that have the effect of transferring a bulk of the reserves into the pockets of Singaporean.

For a party that is very likely to form a government after the elections, a manifesto becomes almost contractually binding because the electorate would remind the party of the promises broken since the last elections, so naturally these manifestos will be laden with motherhood statements but would have few promises. You are expected to live a ruling party's manifesto, not read it.

But manifestos are particularly useful when someone writes it for himself. Writing a manifesto clarifies your thought processes on the nature of success and can teach you a thing or two about your personal life trajectory.

I urge everyone to attempt this and share it on their blog.

If I were to write a manifesto on how to reclaim the Singapore Dream, a draft might look like this.

Reclaiming the Singapore Dream : The Way of the Unnatural Aristocrat

To most Singaporeans, the Singapore Dream is dead.

Globalization killed it.

Data Science and automation will wipe out the dreams of almost all the blue collar workers and a large number of white collar workers within the next 20 years.

The default position is a pessimistic one.

If you are average, the Dream is dead.

No government policy can reverse this.

The way to reclaim the Singapore Dream is to become an Unnatural Aristocrat.

The natural aristocrat is so by virtue of character and talent. You are at best a natural aristocrat at a certain point and time.  Beyond a point in the axis of time, entropy destroys all talent and all meritocratic standards. Demands of industries change.

An unnatural aristocrat is a natural aristocrat who has talents and resources which transcend the progress of time.

How does one become an unnatural aristocrat ?

An unnatural aristocrat is both a rentier and a super-manager.

A super-manager has the skills which are tremendously valuable at a single point in time and are sought after by multinationals and companies. They either solve or coordinate people to solve uniquely difficult and complex problems which cannot be automated. They have mastered techniques which go beyond analytical skills and have a toolbox which can deployed to suit any contextual situation.

A rentier has a resources which last across time. He has may have no valuable skill but his ownership of capital and means of production allows him to sustain himself indefinitely. A rentier acquires an skill set for his own benefit - an intimate understanding of the resources at his disposal and how to squeeze every drop out of his own property. He is trained to structure his ownership of such resources using appropriate legal instruments to the betterment of his family, moving offshore if required.

The super-manager projects power, aggressively trades time for money but can be fragile and forms the Yang of the unnatural Aristocrat. The rentier is passive, obtains money with no time spent, is anti-fragile and forms the Yin element of the unnatural aristocrat. An unnatural aristocrat will find moments where the work is aggressive and his Yang dominates his life and find moments of retirement and introspection when his Yin is ascendant. Yang reinforces Yin when money is channel into investment assets, Yin reinforces Yang when retraining and new skills are obtained.

There is no such thing as work-life balance in one point of time but work-life balance can be achieved across time.

When Yang and Yin are in harmony, earned income flows into assets and assets reflect back passive income.

When passive income equals earned income.

Singapore Dream comes back to life.

Friday, September 04, 2015

Before you vote on Sep 11 : How to make your own minimum wage and unemployment insurance.

I was actually quite apathetic to this year's elections, that is until I came upon snippets of the Worker's Party manifesto on their proposal for minimum wages and unemployment insurance which warrants some gentle intervention from a finance blogger.

But first of all, I don't want this article to lobby for any political party.

Just because I think that WP's ideas on minimum wages and unemployment insurance are wrong does not mean that the reader is being asked to support the PAP. This is because WP will not be able to execute on their manifesto even if gain two more GRCs this year.

Readers are free to support WP as it would have the positive effect of debating their ideas more rigourously.

I also don't want to get too deeply into the politics of minimum wages and unemployment insurance. I am right-winged conservative and readers should know that I will be biased once we get into a political discussion. I'm always for personal responsibility over tax-payer intervention. Tax me less and I will ensure that my family will not be an unfair burden to society.

Instead, I want to show how you can make your own minimum wages and unemployment insurance.

a) Unemployment insurance.

The easier target is to consider unemployment insurance. Based on what little I understand of the manifesto, WP seems to claim that a 0.1% salary contribution from employer and employee can generate about 6 months of pay up to the median income which was $3770 in 2014 for all unemployed citizens. The maths just does not square with me because WP probably made some assumptions about the forward looking unemployment rate when they designed the scheme without considering whether the scheme would actually lead to more people becoming unemployed.

Until I see more evidence, I am inclined to believe that WP drank a lot of Kool Aid when they agreed to publish this idea.What baffles me is that there is a better solution out there : Just let an unemployed person draw from his own CPF-SA a limited amount for 6 months, then make him contribute back when he starts work. No CPF-SA contribution, no insurance.

If you decide to make your own unemployment insurance, simply save 6 month x $3770 or $22,620 after starting work. You can now buy risk-free Singapore Savers Bonds and be your own insurer.

Downside is that you need to be a disciplined saver for 1-2 years if you are a fresh graduate to create this safety net.

Upside is that just holding onto the safety net for a year without drawing upon it will net you $500/year at 2.63%.

b) Minimum wages.

Suppose you have already created your safety net, now you want a synthetic minimum wage.

WP's idea of minimum wages is 80% of $1,250 or $1,000 per month or $12,000 a year. You can roll your own by using a portfolio of stocks with dividend yields.

If your portfolio yields 6%, you need approximately $200,000 to have this portfolio pay your minimum wages. If your portfolio yields 8%, you will only need $150,000 to have this portfolio pay your minimum wages. If you buy only Singapore Saver Bonds, it would require $457,000 to generate these required returns.

( Other financial bloggers do have great suggestions on how you can adjust your lifestyle to save more money and obtain these yields by investing correctly. )

At this point, you will start to protest that I am being unfair.

A WP supporter will say : If a person cannot draw a minimum wage, short of winning Toto, how can he build a portfolio of assets to pay a minimum wage ?

That's my real point : A worker who is worth $500 a month but is allowed to draw $1000 a month is tantamount forcing the business to set aside  50% x $457,000 to sustain him - all for nothing.  That's the whole point about waste which has to be borne by entrepreneurs.

To pay a minimum wage of $1,000, businesses need to ensure that the worker adds at least $1,000 of value. Using risk free assets, it takes close to half a million dollars to generate an effortless minimum wage of $1,000 a month. A very cruel burden to the entrepreneur.

This isn't even a political argument for the upcoming elections - This argument does not even make the PAP look good because Progressive Wages run into the same issues I have raised ! PAP needs to convince conservatives why are the businesses in select sectors providing welfare to workers while other sectors do not need to do so.

I think readers of modest professional means should make it a resolution to create a portfolio to generate a $12,000 minimum wage using whatever instruments which they are familiar with to improve their personal fiscal resilience. While the numbers are modest and can be achieved within a decade worth of work, the true value of this exercise is in allowing someone to appreciate just how much capital it takes to sustain even one minimum wage worker.

Another words, do it for yourself, then judge others based on your own personal experience.

After you determine whether it is fair to impose this financial burden on the business man, tax payer, or the individual, then you would be able to vote your preferred party without regret or remorse.

Wednesday, September 02, 2015

How to seek financial knowledge ?

Budget Babe was the first blogger to respond to the POSB advertisement which exhorts Millennials to surrender their financial futures to financial adviser.

You can find the posting here.

I'm going to post the next logical step which would take the reader towards building a basic foundation in personal finance.

Here are the bare basics before you even start on reading a financial book :

a) You run your life like a business.

A good way of framing your financial life is that you are running a business regardless of what kind of vocation you are in. Your salary is a result of you selling your time to an employer. The food, transport and luxury watches you buy for yourself are expenses. Everything that costs money is an expense : this includes your internet connection bills and management fees of unit trusts. The only thing of true value is what remains after your deduct your expenses every month.

This constitute your savings and investments.

b) Choosing your investment is like choosing an employer.

The second fundamental is that you need to choose a good investment the same way you choose  a good employer. You exchange your time for money so you should take steps to maximize this exchange rate. Always gun for jobs which give you the highest remuneration for your time. Upgrade your knowledge once you hit a plateau in your hourly income.

Similarly, it does not make sense to invest in something that subject you to high expenses and pay your less per unit time. ILPs. unit trusts and hedge funds are generally speaking high costs because not only do you need to pay your financial advisor, you have to pay your investment manager as well. Exchange traded funds and individual stocks are generally low cost if you can minimize brokerage by making bigger buys but they are not marketed aggressively so a lot of DIY effort is required.

c) Compounding makes you rich. 

The third fundamental is that compounding, and not trading, that makes you rich. Money grows exponentially at a compounded interest rate. When someone takes a risk at 8% over 25 years, he will be much richer than someone who takes no risk at 4%, he just needs to stomach more volatility.

To be able to stomach risk, you need a longer horizon which means that you need to start young and compound your assets at a higher rate in your twenties. If you surrender your financial fate to an advisor at a young age, your assets, which could have compounded for the next 40 years, are converted into his commissions, allowing him to reach financial independence and attend more MDRT conferences.

d) Read to build your knowledge.

Once you have these basics in place, in my opinion, your first step is not to jump on the Warren Buffett bandwagon. You should also avoid works which focus too much on motivation and too little on technique. ( Robert Kiyosaki and Harv Eker comes into mind )

A book which balances some motivation and gives you the basics to get started is George Clason's Richest Man in Babylon.

Many of us financial bloggers have products on sale which arms you in the basics on how to get started.

My own product here is Sowing Your Seeds of Prosperity. BigFatPurse has an excellent book on building a Singapore Permanent Portfolio can be found here.

But do not stop there : The holy grail of personal investing is to eventually be able to understand and apply principles in The Intelligent Investor. Mastering this book allows you to take charge of your own portfolio and financial life.

As money is a very interesting topic which I find pretty easy to get obsessed about, I also encourage every beginner to consider taking the CFA exams.

This exam has a ridiculously low pass rate but studying for it can result in a better looking resume - exactly what a young 24 year old would do instead of surrendering his financial future to a so-called advisor.

But generally most readers who are familiar to this program will consider this suggestion overkill.

If you are fresh graduate in your 20s, you are not too old to learn something new. The opportunity cost of picking up skills in personal finance is much lower as your are single and have few commitments.

Don't surrender your fate to a financial advisor.

Become a financial advisor for yourself.