Recommended Reads

This blog posting http://atans1.wordpress.com/2009/12/26/where-gic-and-temasek-gets-their/ explains the links between your CPF monies and S'pore's reserves. There is a link but the losses of Temasek and GIC will not affect your CPF monies because CPF invests in a special Singapore government bond. If the government ever defaults on this bond or other government bonds, it will be a pariah state.

A very conservative approach to share investing for 2010? And make sure you read the bit about “asymmetric consequences” if you are thinking of buying big time the next time market falls a lot (like in March 2009).

http://atans1.wordpress.com/2009/12/31/investment-strategy-for-2010/
And these show yields on S-Reits and local stocks.

Many people are risk averse. They are afraid of taking investment risks and making a loss. The investments that gives the best long term return are equities, but they are also the most volatile, i.e. the price can go up and down by a large percentage in a few days or weeks.

A long term investor should not worry about the short term changes in the price of the shares. As long as they keep the shares, they do not have to take a loss. The value of the shares will eventually recover and give an attractive return. This has been the trend over the past years.

There is the risk of selecting the wrong shares, which may perform worse than the market or may even go bankrupt. This risk can be minimized through diversification, i.e. investing in a fund comprising of 10 or more shares. Some shares in the fund may perform badly, but they will be offset by the other shares that perform better than the market.

There is still the market risk. In a bad stock market, most shares will perform badly. The bad market may last for a few months or even a few years. A long term investor is able to ride out the bad years and will be compensated by the good years, to get an above average return. I describe this strategy as "averaging out the good and bad years".

By investing in a fund, the long term investor does not have to worry about picking the right stocks, or managing the individual investments, such as collecting the dividends and subscribing to the rights issues and other corporate actions. These fund manager will take care of these activities.

It is important for the long term investor to choose a fund that have low initial and annual charges. They can choose an exchange traded fund (ETF) that meets these two criteria. The STI ETF has a transaction charge of 0.3% and an annual management fee of 0.3%. Some other ETFs have higher annual charges, but they are usually less than 0.7%.

The investor can choose a unit trust that has an upfront charge of about 2% and an annual fee of about 1%. The unit trust is actively managed and is aimed at producing a better return than an ETF through the active selection of the fund manager. Research has shown, however, that over the longer term, the actively managed unit trusts perform worse than ETF, after deducting fees.

If you select the right unit trust, you may get a better return than average, but the challenge is selecting the right fund. It has been found that past performance is not an indication of future performance. Choose the funds that performed well in recent years may not be a good strategy.

For a long term investor, the tip is, invest in an exchange traded fund that have low annual charges, of less than 0.5%. Invest for the long term and do not worry about the fluctuations in the market. This type of investment is better than investing in life insurance policies, due to the extremely high charges taken by life insurance companies (usually 3% per annum).

The writer is Mr Tan Kin Lian, Chairman of FiSCA and ex-CEO of NTUC Income
View his original blog post here

Participating policies, i.e. endowment or whole life policies, are designed to provide a guaranteed yield at a modest level (say 1% p.a.) and to provide variable reversionary and terminal bonuses that can increase the yield to a higher level. The bonuses are declared each year based on the financial results of the insurance company.

In the past, most life insurance companies were able to give an attractive yield to the policyholders. The insurance company invest the money well with a long term perspective and were able to achieve an attractive return. After taking away a fair proportion to cover their expenses and profits, they distribute most of the surplus to the policyholders with a high rate of bonus.

The insurance company maintains a manageable number of policy series, and distributes the same rate of reversionary or terminal bonuses to all policies in the same series. The policyholders in each series can see that they have been treated equally with other policyholders in the same series.

This practice has changed in recent years. Insurance companies have introduced too many policy series and distributes different rates of bonuses to policyholders in the same series. It is difficult for any policyholder to be sure that they are getting the fair rate of bonus, based on the actual experience of the fund.

To make matters worse, some insurance companies retain too much surplus in the fund, under the purported aim of  "smoothing the bonus", or use the surplus to pay for high expenses, resulting in a poor yield to policyholders.

It is the lack of clarity that gives a bad name to participating policies in recent years. Many policyholders find that the projected bonuses made at the inception of the policy had been severely reduced due to "difficult investment climate", but it is not clear if the reduction is due solely to this cause or to other unethical and unfair practices.

To overcome this problem, the insurance company can adopt the "asset share" method to distribute bonus. This method ensures that each policyholder gets its fair asset share on the surrender or maturity of the policy based on the actual experience for that policy. It is quite to adopt this method using modern computer technology.

Some countries make it mandatory for the "asset share" method to be used, to ensure that the policyholders are fairly treated. The regulator in Malaysia took this step many years ago, in their effort to protect the interest of the consumers and to ensure fair practices.

In Singapore, many insurance companies have severely reduced their reversionary and terminal bonuses in recent years, often more than expected.  Many consumers have lost trust in the participating policies and the insurance companies that sold these policies.

I hope that the regulator in Singapore will implement the "asset share" method early, to ensure that all policyholders are given a fair return in this volatile situation and that the trust in participating policies can be restored.

The writer is Mr Tan Kin Lian, Chairman of FiSCA and ex-CEO of NTUC Income
View his original blog post here

This extract explains that other than buying proportionately the underlying shares of the indice it is tracking, an ETF sponsor has two other ways of constructing an ETF. The sponsor could mimic the index by buying only a sample of the stocks. This is called "representative sampling". If it gets the sampling wrong, the ETF will not track the index that closely: in the jargon, the tracking error is greater.
 
A sponsor could also replicated an index through derivatives usually via swaps. This means that the ETF is a structured product. Now after the Minibonds, and HN5, Jubilee and Pinnacle notes debacle, structured products have a bad name. But ETF sponsors claim that they do everything they can to mitigate the risks. And while the stock exchanges that list these EFTs legally have no liability if these EFTs go wrong, their reputations are on the line if structured ETFs go bust.  
 
From a 2009 BT article republished by the CPF Board. Link to article is provided below
 
But as ETF penetration grows, investors should be aware that not all are created alike. While most ETFs are designed to track an underlying index, there are actually two to three types of structures, each with advantages and risks.

The first type is what most investors would be familiar with - ETFs that replicate an index by physically investing in the index's component stocks. SSGA's streetTRACKS STI is an example of this. Then there are ETFs that replicate the index through a 'representative sampling'. As the term indicates, this takes a sample of stocks that approximates the index's performance.

Then there is the synthetic structure, where index performance is replicated through derivatives, usually a swap arrangement. This is typically done for markets where access may be difficult and liquidity poor. Those listed here by Lyxor and Deutsche Bank's db x-trackers series are swap-based ETFs. ETFs that track the China A shares indices on the Hong Kong exchange also do so through derivatives.

Cash-based ETFs, which seek to buy an index's underlying shares or a sampling of shares, offer the comfort of transparency and are relatively easy to understand. The drawback is that there may be deviations from the index, which in industry parlance is called a 'tracking error'. This occurs when weightings of underlying stocks shift, or the components are changed and the portfolio needs to be rebalanced, for instance. Performance between ETFs that track the same index may vary. The performance of DBS STI ETF, for example, has lagged the FS STI Index by more than 2 percentage points.

Managers of cash-based ETFs may lend out the securities. While this generates revenue for the fund, it incurs counterparty risks. SSGA says it does not engage in securities lending for its Asian ETFs.

Swap-based or synthetically structured ETFs offer the advantage of a tracking error that's virtually zero, says head of db x-trackers for Asia, Marco Montanari. In a swap based ETF, the fund holds a basket of securities which may be completely unrelated to the index it is linked to. It enters into a swap agreement with a counterparty where the latter undertakes to deliver the performance of the index to the fund. The fund on its part will deliver the returns of its basket of securities.

Such an arrangement, of course, also raises the spectre of counterparty risk which loomed large through this recent credit crisis. A case in point are the London-listed commodities funds of ETF Securities, which had AIG as a counterparty. As AIG teetered on the brink last year, the funds plunged in value and were suspended from electronic trading.

Yet another issue is that there may be little transparency on the types of securities held as collateral for the swaps, which may themselves plunge in value in a crisis. There is of course no guarantee on the value of the collateral.

There are ways, however, to mitigate the risks. European funds, such as those structured under the UCITS III umbrella, are subject to a cap of 10 per cent in terms of counterparty exposure. UCITS refers to the authorisation regime for funds in Europe.

Managers themselves can go the extra mile. For db x-trackers, Deutsche Bank as the ETFs' swap counterparty has set up an account with the fund custodian in which cash and securities are pledged to the account. The collateral is subject to concentration limits. There is for instance a 4 per cent cap on any single security.

Full article, courtesy of CPF Board
 
http://www.cpf.gov.sg/imsavvy/infohub_article.asp?readid={460637084-2739-872464179}

I told this story a few months ago, and wish to repeat it.

A polytechnic students told me that he received a monthly allowance of $600 from this father, who is a bus driver. His friend sold him two life insurance policies that takes away $300 a month in premium. He knows realize that it was a bad decision, as he needed the money for his schooling and other expenses, and finds it difficult to pay the monthly premium. If he gives up the policies, he would suffer a large loss in the premiums that he had paid. He is now in a dilemma.

I like to advice young people to avoid taking life insurance policies, as a large part of the premium during the first few year goes to pay the commission to the agent. If you stop the policy, you will lose more than half of the premiums that you have saved. You will need the savings for other unexpected events.

My same advice goes to young people starting work for the first time. The insurance agent will sell you a life policy or investment-linked policy. They are all the same. You will get a poor return and a large part of your premium goes to pay commission to the agent.

Many people save in a life insurance policy (and be tied up for 20 years for a miserable 2% return), and roll over their credit cards paying 24% per year. This is bad financial management.

It is important for you to save, but you should save in a bank account. If you need to withdraw your savings, you do not have to suffer a penalty. If you wish to invest, do it at a later date, and invest in an exchange traded fund (such as the STI ETF) which has low transaction charges and gives you a good long term return.

But, before you invest, you can read my book "Practical Guide to Financial Planning", which will be available  in March 2010, or join the Financial Services Consumer Association, FISCA (www.fisca.sg)

The writer is Mr Tan Kin Lian, ex-CEO of NTUC Income
See the original post on his blog here

Redundancy is defined as retrenchment and premature termination of contract. It represent loss of employment that is initiated by the employer. There were 16,000 redundancies in 2008 and has already reached this fugure for the first 9 months of 2009, representing 0.8% of the employed population.

This figure does not represent involuntary loss due to "difficulty of working with management" or "asked to leave". If the other reasons are included, the redundancy rate is likely to be much higher, maybe 2% a year or higher. The risk of being terminated during a working life could be more than 50%.

Many workers who are lost their jobs involuntarily will face difficulty in getting another job that pays equally well.  There are many mature workers who have been unemployed for several years.

It is important to be financially prepared for involuntary loss of job. Here are the necessary steps:

a) Have liquid savings representing 6 months of earnings
b) Reduce your fixed commitments, especially on life insurance savings
c) Buy a property that represents not more than 4 or 5 years of the family income (after deducting cost of employing a maid)

You should avoid savings in a life insurance policy, as the regular premiums will be a financial burden when you are unemployed, and you will suffer a large loss, or penalty, if the policy is terminated early. If it is terminated within the first five years, you may lose up to 50% of your savings. You can only break even if you pay the premium for more than 15 years, in most cases.

It is better to save in a savings account or save-as-you-earn account (which pays slightly higher interest) and invest in an exchange traded fund, money market fund or a unit trust that has low initial and annual charges. If you have to withdraw your savings, you do not suffer a penalty, but you do have to take the market risk.

These concepts are explained in my book "Practical Guide on Financial Planning", which will be available in the bookstores in March 2010. It is important for young people to be educated about these principles before they start work, and to avoid locking up their savings in an inflexible, high cost, life insurance policy.

You only need to worry about medical insurance (e.g. Medishield) at the start. You do not have to worry about life insurance until you are married. After marriage, you can have Term Insurance or Family Income benefit at a low premium (say, 1% of your annual income). You can check this website for an indication of the premium for Term Insurance.

The writer is Mr Tan Kin Lian, ex-CEO of NTUC Income
See the original post on his blog here

An interesting video on how the UK is planning to teach kids about managing personal finances. Ask your kids' school principal if there are plans for this kind of training here? FYI FiSCA has plans to teach kids about managing personal finances.

FiSCA hopes that this will help you understand the CPF Life schemes.

CPF Life.pdf

A few days ago, this was linked http://atans1.wordpress.com/2010/01/01/the-perils-of-indexation-revised-and-updated/ explaining that investing in equities indices could go wrong. It is not a "no-brainer".

This NYT article explains how in the US context  investors could have come out ahead in the last decade through a plan of diversification, regular investments and annual rebalancing, all using low-cost index funds.