How To Retire Well

How To Retire Well

Investment is an integrated part of any retirement plan. The success of the retirement plan is very much dependent on the ability to achieve the projected rate of return on the investment.

In a dynamic market environment, the projected rate of return on investment may not be achievable. Therefore all investors should approach their investments with extreme care.

Investment is an art not a science. There is no one single strategy or formulae that will produce superior return consistently over a period of time.

Having said that, however a well-defined investment plan will help to minimize the mistakes that most investors make and enhance the chance of a positive outcome of the investment portfolio. The main advantages of this are that it imposes discipline on one's investment plan and prevent random rebalancing of portfolio based on panic or overconfidence.

An Investment Plan should cover the following basic areas.

Risk

The amount of risk that the investor can tolerate, how much the individual can afford to lose? Can he sleep soundly when his portfolio value declines significantly?

Return Objective

The investor must establish his investment goal and be committed to the goal. For example achieving a quantifiable dollar amount at retirement to finance his retirement plan.

Constraints

The investor will also need to take note of possible constraints. The liquidity needs of the family in the near future must be addressed in the plan. The investment time horizon is another important factor, as it will have an impact on the asset allocation decision.

Asset Allocation

Asset allocation is a process of allocating the investor's financial resources across different asset classes based on his risk, return objectives and constraints. The future market expectations are brought into consideration too. Typically the asset classes will consist of equity, fixed income, property or REIT and others.

Asset Classes

Investor can gain exposure in the equity market through direct investment in shares, equity funds and exchange-traded funds (ETF).

The rate of return for fixed income instrument is lower than equity in a long-term horizon. Fixed income instruments are poor hedge against inflation. However, it is included in the portfolio to reduce risk and volatility of the portfolio. Investment in fixed income instruments can be achieved by direct purchase of government or corporate bonds and fixed income funds.

Property and REIT are another asset class, which has generated high rate of return in the past. However, there is a liquidity and marketability problem of physical property in a bear market. REIT is more liquid as it is traded in stock exchanges.

Hedge fund is getting popular in recent days due to the fact that investor is seeking alternative asset classes to reduce portfolio risk and enhancing return. Based on the Hennessee Hedge Fund Index, hedge fund has posted annualized returns of 18% from 1987 to 2001.

Despite all the good publicity about hedge funds, investor should not to jump into hedge funds in a big way. Hedge funds tend to lack transparency in the portfolio holdings and these funds use complex investment strategy. In addition, hedge funds come in all types and varieties such as fundamental long-short, quantitative long-short, merger arbitrage, relative value funds, macro funds and funds of funds. All this, make the risk assessment and understanding of hedge funds a tough job. The near collapse of LTCM in 1998 will serve as a remainder to the risk associated in hedge funds investment.

Portfolio Construction

Once the asset allocation decision (composite of asset mix) is made the investor can proceed to construct his investment portfolio. He can build up his portfolio through direct investment in securities, funds and exchange-traded funds. Ideally the investor should construct a well diversify portfolio to reduce risk. The key reason for diversification is uncertainty of the investment outcome. If one can be certain about the outcome there is no need for diversification. Investor should also take note of unwarranted portfolio concentration due to the overlapping of portfolio holding in the funds when funds are used as investment vehicles in portfolio construction.

Review And Portfolio Rebalancing

Over time as asset prices change, the asset mixes drift away from the optimal level. Investor's risk, return objective and constraints will change as time passes. This creates a need to rebalance the portfolio. Generally there are 2 approaches to rebalancing of portfolio. Ad hoc rebalancing, - whereby the portfolio is rebalance when the investor thinks it is appropriate. And, discipline rebalancing - where it requires the portfolio to be rebalance in a systematic way. For example rebalancing is done on a semi-annual basis or whenever any asset mix drifts more than 15%(said) from it optimal level. Studies have shown that discipline rebalancing works best as compared to ad hoc rebalancing (market timing).

Lastly the investor needs to evaluate and review his plan as time passes and make the necessary adjustments along the way to ensure the success of the plan.

The actual development of investment is much more complex and therefore professional advice is usually required. In addition investors are advised to set aside enough emergency fund (6 months of monthly expenses) and have sufficient insurance coverage before embarking in investment planning.

Contributed by:Mr Poh Koon KiatCERTIFIED FINANCIAL PLANNERTMMember of Financial Planning Association of Singapore