Sunday, May 26, 2024

What a beneficiary can do with inherited sums from a departed loved one

Recently, a friend has lost a loved one and has questions about what to do with sums of money left by that loved one. I wanted to write an article explaining my thoughts on what to do if you have a windfall from a departing loved one. 

Before I begin, I want to share that, as human beings, we would usually not treat inherited wealth as earned wealth, so I think the insights from behavioural finance experts on mental accounting may not be helpful when we are still grieving the departure of our loved ones. Even after more than five years after my dad was gone, I still segregate his sums in a separate account and would only use the capital for medical reasons. The dividends are also reinvested most of the time. 

The most important thing I would not do is pass the sums to a banker or financial advisor. As this involves AUM or commissioned sales, it would be tantamount to allowing the FA to inherit the wealth, so all my solutions I will discuss involve the DIY handling of sums of money.

Here are some of my considerations :

a) Singapore Savings Bonds (SSBs)

The most basic answer right now would be SSBs. This is the closest thing to a riskless investment and guarantees that capital can be preserved. SSBs yield 3.28% for the first 3 years, which is slightly higher than the inflation rate of 2.7%. However, it is still being determined whether it can continually beat inflation as the years go by. Finally, you can only have a maximum of $200,000 SSBs in your CDP account. Payouts occur every April and October when stocks generally do not pay dividends. 

b) Globally diversified ETFs with a discount broker

A more savvy solution is to do what most savvy retail investors do: put it with a discount broker and then buy a diversified pool of ETFs from different asset classes. The expense ratio can be meager, at below 0.3% per year (unless it's commodities). You can optimise on taxes by buying accumulating funds and UCITS ETFs on the London Stock Exchange.

I backtested a portfolio that invests 25% in stocks, REITs, bonds, and ETFs. Average returns exceed 7%, with a low standard deviation of around 12-14%. However, this asset allocation must be rebalanced annually, so there's an administrative overhead.

The biggest issue with this approach is that it is emotionally less satisfying as you need to liquidate to spend the sums. There may be a sense of unease with inherited sums, but spending about 2.5% of the prevailing amounts yearly should adequately preserve wealth and even allow payouts to grow over time. 

c) Local dividend stocks

Performing some factor selection of local dividend stocks may only slightly underperform the ETF suggestion and even result in a higher standard deviation. Still, Singapore markets have already gone through some terribly wrong days and are cheaper than foreign markets. Picking 20 blue chips with the highest yields and then cheery picking 10 with the lowest volatility can generate returns of over 8% for the past 10 years with single-digit standard deviations.

While the historical data looks good, this strategy's real strength is its emotional appeal. The more diversified your dividend portfolio is, the higher the frequency of payouts. If you are willing to pay a fee for higher trading costs, stocks in the CDP system can even be paid directly to your bank account at 5.30pm on a payout day.

This is particularly good for grieving individuals as it feels like your loved one is always looking after you and sending you money to buy a meal at the restaurant. I suspect this is one of the reasons for 1M65's hilarious outburst that SGX is all about Kiasu and Kiasi investors who will not take a risk on innovative tech counters. As such, I actually think Mr Loo Night would be right, but we dividend investors would like things to stay this way!

The downside I noticed about this strategy is that it is, after all, focused on high-yielding stocks of a single country, so the strategy can have its bad days. You can occasionally have drawdowns that are very large compared to the ETF strategy. 

As for me, I did not have to convert my father's holdings into dividend counters because I had been doing it with his blessing for decades while he was still alive. He transitioned from asset to cash-rich, while I did the opposite as I took on a mortgage loan for my executive condominium. These days, even closer relatives remarked how much I now looked like my dad as I reached my 50s.

Right now, I can share some of my thoughts because I collect rentals from a shophouse my father bought when I was a JC student in JB every few months. This shophouse supported me when I was getting my first degree. The ringgit has weakened immensely, so after all my diabetic meds and my mum's blood pressure meds, there's only so much left to buy relatives a treat in KSL

I always tell my uncles and aunties not to thank me as the money came from my dad's savvy moves when he was younger. 

My dad would have been 82 years old next Friday.

I hope he would approve of my actions as a steward.

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