Saturday, June 19, 2010

Future planning

Roy Varghese

Director, financial
planning practice,
ipac Singapore

UPPER middle-class families in Singapore typically have four main lifestyle goals: replace the family car every five years, upgrade the primary residence at least once, educate the children overseas, and achieve financial independence by age 60 or so to enjoy a comfortable retirement lifestyle. But unless the family's combined household income is in the top 10 per cent bracket nationally, there are limitations and trade-offs to consider before constructing a realistic financial plan that includes all four goals.
Car ownership
The price of new cars has fluctuated considerably over the years owing to COE, import duties, foreign currency exchange rates and so on. If we assume that our model family owns a 2-litre Japanese car which they replace every five years over a 40-year period, this is how the math works out in the Singapore context. At an average price of $120,000 (in 2010 dollars) for a new car, the monthly instalment for the car loan works out to about $1,000. The road tax, insurance and maintenance costs add up to another $500 per month. The cost of petrol, ERP and parking fees similarly may cost a further $500 each month. From age 30 to 70, this couple will have paid the bank close to $500,000 in absolute dollars ($1,000 per month over 480 months) for owning a new car and replacing it every five years or so. The price for convenience makes car ownership the top lifetime consumption item and drain on family resources. With the money spent on eight new Toyota Camrys or Honda Accords, you could send two kids to Princeton or Columbia, if they manage to get admitted.

Home mortgage
Let's paint a picture of a hypothetical couple's home ownership pattern. They graduate from university, work for a few years, marry at age 28 or 30, buy an HDB apartment for $300,000 and then upgrade to a private property by age 35. If we assume a very nice condo or even a terrace house, the purchase price in 2010 dollars would be about $1.5 million, without renovations. We can amortise renovations over the life of the house and treat this as an operating expense rather than as capital expenditure for the purpose of our analysis.

Let's assume that the HDB flat was fully paid for at the time of sale in 2010 and that the proceeds were used as equity in the upgraded private property. At an average interest rate of 3 per cent pa, the $1.2 million mortgage over 25 years would result in a monthly outlay of $4,000 in cash and CPF. The interest element to the bank for the financing of the private home would be about $600,000 in total.

It may appear that the borrowing cost for the home is comparable to the money spent on cars. However, there is a crucial difference - the home has an investment value in retirement whereas the cars depreciate the moment they leave the showroom.

Saving for retirement
This is the one long-term goal that almost everyone has in their financial plan. 'We need a retirement income of $5,000 per month in today's dollars from age 60 onwards.'

A very modest lifestyle aspiration indeed and realistic too. If you exclude mortgage payments, income tax, life insurance premiums, and the children's higher education costs, the model couple can live comfortably on $5,000 per month if they retire today.

To make the retirement capital last till 90, without having to sell the family condo or terrace house, this 60-year old couple would need to accumulate at least $1.5 million today. With a combined monthly household income of $12,000 by age 40 (see The Business Times March 20, 2010 'Double Your Income Every 10 Years'), it is possible for our hypothetical couple to save and invest an average of $4,000 per month over 20 years for the target retirement capital accumulation. This works out to about $1 million ($48,000 per year over 20 years) saved or twice the amount spent on cars or mortgage interest on the home. An average annual rate of return of 5 per cent compounded over 20 years will provide this couple with the nest egg for their retirement lifestyle.

Apart from having a roof over your head, saving and investing for retirement is a non-negotiable financial goal. The issue for young and middle-aged parents is: can you afford the trappings of upper middle-class lifestyle (present and future) and educate your children abroad at a world-class institution?

Ivy League education
If you embark on constructing a comprehensive financial plan in your early 40s, funding your children's tertiary education is usually a medium-term goal. If you have 8-10 years to save and invest for the children's university education, there is a high probability this can be achieved without having to compromise your other financial goals. The math is fairly straightforward. If you wish to send your child to SMU, NUS or NTU, the cost is about $50,000 per child for a 3-year degree program in today's dollars. This is almost the equivalent of financing one new Camry per child's entire local tertiary education. In order for your child to graduate from Yale University, parents will have to shell out S$300,000 today for a 4-year undergraduate programme.

If you have more than one child, good luck as you have to play Solomon and decide who stays home and who gets to go to New Haven, unless your resources are unlimited or there is a scholarship available for at least one child.

There is no doubt that our children can receive quality tertiary education in Singapore despite the widely-held perception in some circles that a degree from a prestigious foreign university provides an edge over a local degree. There is no data available to suggest that an Ivy League education guarantees a higher lifetime income compared to local degrees. It may be that a child who qualifies for admission to an Ivy performs better in her career because she is a high achiever by nature.

In conclusion, there are some lessons to be drawn regarding funding overseas tertiary education. If you can accept driving a smaller or used car, there is some hope of capping spending on car ownership. The affordability of housing is critical in limiting finance charges for owner-occupied private property.

By the time you are 50, you will most likely have set money aside for your children's local or overseas education. This means that retirement funding is typically the last goal to be realized and for some, this may be leaving it too late. To fund a comfortable retirement lifestyle, a good number of upper middle-class families may need to trade down their private homes in their 60s to make up for the shortfall in liquid assets.

I know many parents are happy to scrimp and save so that their children can enjoy the returns on a world-class education. And it is laudable to help our children realise their dreams and reach their potential with a branded college education. But unless we are confident about being financially independent in retirement, it is best to consider trade-offs for the big ticket items in life before promising our children an expensive overseas university education.

• The writer is Foundation Adviser at ipac Singapore. These views expressed are his own and not ipac's.

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