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The Sobering Truth about Your Retirement Savings

coins in nestRetirement is a word that often brings positive connotations and mental images of the good things in life such as; ample amounts of personal time; leisurely evening strolls; holidays; and fun with grandchildren, to name but a few. Unfortunately, for some, ‘retirement’ might just mean an endless struggle on the Money-hill.

Many might think savings will do the trick in providing for retirement, but I’m not so sure.

Savings Are Key, But They’re Never Enough

Let’s consider a Singaporean with the following characteristics:

  • He expects to retire at 65 and live till 90
  • He currently has $20,000 set aside for retirement
  • He wants to draw an inflation-adjusted retirement income of $2,000 per month for all expenses, i.e. he wants an income that’s able to purchase $2,000 worth of goods and services today when he hits 65.
  • He lives in a mild inflationary environment where the rate is at 2.5% (for comparison, Singapore’s average historical inflation rate since 1962 stands at 2.8%)
  • He expects his savings accounts to generate interest at 2.5%, compounded annually.

Now, the chart below shows two figures; how much an individual needs in his piggy-bank, depending on his current age, when he hits 65 years old; and how much an individual needs to save annually to hit that amount.

sobering truth 1

According to all the characteristics described above, if the Singaporean was currently at 20 years of age, he would need $1.82m in his piggy-bank when he hits 65 and would need to save $21,100 annually!

For someone who’s 35, his savings-accounts better be padded with $1.26m in cash when he’s 65 years old, or he would need to live on an inflation-adjusted retirement income of less than $2,000 per month. To top it off, he would need to save $27,000 a year – that’s a tall order, considering that the average annual wage for an employee in Singapore was $36,000 in 2012.

To add even more fuel to fire, a key-assumption going into this graph was a 2.5% interest rate on the person’s savings. Besides our CPF accounts giving us interest rates of 2.5% – 4%, normal savings accounts from banks like DBS (SGX: D05) offer rates of only 0.05% to 0.25% depending on the type of account and the amount deposited. At much lower interest rates, the figures that an individual needs for retirement becomes even larger.

Simply put, depending on savings alone will be a tall order when it comes to surmounting the obstacle known as ‘Retirement’.

Growing Your Money

A better alternative to just plainly saving, would be to save and invest. Let’s use the same Singaporean with the same characteristics as before, but with one crucial difference – this Singaporean invests and can conceivably make 8% a year, compounded.

sobering truth 2

Comparing both charts, we see that a Singaporean who’s currently 20 would need to save $1000 a year to achieve his retirement goals. And, if his portfolio continues to grow at 8% even after the age of 65, he would only need to have $1m, compared to $1.82m he needed previously.

For someone who’s 35, he only needs to save $4,200 annually, a far cry from the $27,000 he needed in the previous example.

That’s what investing can help us achieve – larger output with smaller input – especially when compounding is given time to work its magic.

Now, let’s invest!

At the Motley Fool Singapore, we believe that investing in individual companies’ shares in the stock market is one of the best ways to build lasting, long-term wealth and to help grow an individual’s retirement nest egg. But, that entails time and effort from investors in studying individual businesses.

Investors can avoid that kind of difficulty and effort by choosing to invest in the broad stock market through Exchange Traded Funds that track stock market indices.

Singapore’s most common and widely-followed stock market index would be the Straits Times Index (SGX: ^STI) and it has returned 270% since the start of 1988 to 24 June 2013’s close of 3,074 points. That’s a 5.3% annualised return without considering dividends, which would surely improve the return-figure were it to be included.

There are two ETFs that aim to replicate the STI’s movement as closely as possible; the SPDR STI ETF (SGX: E3S); and Nikko AM Singapore STI ETF (SGX: G3B). Investors can gain an exposure to the broad stock market with these ETFs. The SPDR STI ETF has returned 5.9% a year (exclusive of dividends) since its inception on Apr 2002 while the Nikko AM Singapore ST ETF has grown by an annualised rate of 21% per year (inclusive of dividends) since its inception on February 2009.

The Nikko AM Singapore ETF’s return seems remarkable but we must bear in mind the fact that the fund got started during the trough of the Great Financial crisis of 2007-2009, when the stock market was severely beaten down to very low level. That set up the stage for strong returns going forward, but it’s certainly not sustainable over the long-term (measured over decades).

In any case, the returns from investing in an ETF won’t make anyone a millionaire overnight, but that’s not what the stock market is about. If history is any guide, prospective returns from the ETFs can go a long way in buffering up the savings for an individual to prepare for retirement.

Foolish Bottom Line

It’s going to be difficult to retire on savings alone and hopefully the math that’s presented makes the difficulty clearer.

A million bucks seems like a big deal for most, but when you hit 65 years of age 30 years down the road with no source of income from investing, $1m at that point in time can’t even pay you $2,000 a month until you kick the bucket at 90 – that’s sobering, isn’t it?

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Chong Ser Jing doesn’t own shares in any companies mentioned.