Retirement Goals, and How to Get There

lifefinance
October 29, 2019
8
CPF, Insurance, Investing, Saving, Withdrawal

We all have pretty good ideas what our immediate life goals are. For example, to travel the world, buy a car, find a residence, start a family, and so on and so forth. But achieving these immediate life goals doesn’t necessarily mean we are on track with our retirement goals. In fact, we may find ourselves drifting further and further away from our retirement goals even as we meet those immediate life goals and priorities.

How then should we start getting on track for retirement? The usual advice would be to start saving and investing and hope we will have enough to retire comfortably on. We are told to keep track of how much we spend, and how many years of retirement we expect, to work out the amount needed upon retirement to meet those spending needs. This is think from the start point, i.e. today.

But that is leaving it to luck that things will work out the way we hope in retirement. Or, we can work backwards from the end to see what needs to do done today to ensure a worry-free retirement. Sometimes working backwards gives us insights that we may not have when we think from today’s point of view. A parable may help illustrate this:

The Prisoners’ Dilemma

The Prisoners’ Dilemma is the best known example of game theory. In the story, two gang members are arrested and imprisoned. Each prisoner is in solitary confinement and cannot communicate with the other. The police lack sufficient evidence to charge them for rioting, but can charge both for obstruction of justice. The police offer each prisoner a bargain. Each prisoner is given the opportunity either to betray the other by testifying that the other rioted, or to cooperate with the other by remaining silent. The possible outcomes are:

Prisoners’ Dilemma Payoff Matrix

From the payoff matrix, both prisoners are better off cooperating and staying silent (-1,-1). But they also know that they are individually better off betraying the other prisoner if the other fellow stays silent (0,-3). Since they cannot communicate, they will decide in their own self interest to betray each other. This results in a worse outcome than if they had cooperated (-2,-2).

Repeating the Prisoners’ Dilemma

But what if they had a chance to reconsider their statements every day knowing what happened the day before? Would they cooperate? At first glance, the answer is yes, since if A knows B cooperated the previous day, A would encourage this by cooperating as well. And if B betrayed A the previous day, A can punish B by betraying him this time round.

Surprisingly, if this were to be repeated a finite number of times, say, for 30 days, the outcome is likely to be that they will betray each other from Day 1, and every day after that. Why is this so? This is because A knows that B will betray him on the last day, since there are no future statements to make. So, A might as well betray B on the last day. And this means that they betray on day 29 as well, since they cannot punish each other the next day. And so on, until Day 1.

What has this got to do with retirement goals? The point of this parable is that we really need to look at the last period of life, and not just the point of retirement, if we want to make sure we getting our priorities right. We may be concerned with the lifestyle we can afford upon retirement, but we also need to consider expenses much further in the future. Questions such as: do we leave a bequest when we pass on, do we need cash on hand to meet high medical bills, and what if income runs out, or stock prices collapse?

What are our Retirement Goals?

So what are the end-of-life retirement goals that we need to focus on? For starters, there are four big ones:

Liquidity, or cash on hand: Even with a steady stream of income in retirement, there will be large lumpy expenses. Perhaps because over the course of retirement, the home needs to be renovated or fixed more than once. Or because the end-of-life medical bills and co-payments exceed the Medisave withdrawal limits. Or because one of the kids needs the cash to pay for a wedding, or the delivery of a child.

Income, a steady stream of income, rising with inflation, to pay for the day-to day living expenses. This should cover the occasional treat, and travel to other places. As we age, we usually consume less (we may get too old to travel the world at some point!). So this income can be a little higher at the start of retirement, and flatten or taper off later in life.

Healthcare, having the resources to pay for medical costs such as surgery and hospitalisation or long term care. These are too large to be covered, except with health insurance. However, co-payments, deductibles, chronic conditions not covered by insurance, out-of-pocket expenses, medication, can all be a significant drain on the resources we have. So there must be cash resources on hand to cover these costs as well, and they are most likely to pile up towards the end-of-life.

Bequest, to leave something for our children. No matter how much we say giving our children money will spoil them, we still want to do this. Because, surely, life consists of more than just living our own lives and leaving nothing behind. And being able to gift something when the need arises, and not only upon our passing. Sometimes it is the timing of the bequest of gift which makes a big difference to the recipient. As we are living longer, our own children would be in their 50’s by the time we pass on! At that age, the bequest may not make as large a difference to them compared to something which could have helped them a decade earlier.

Meeting Retirement Goals

So how do we get there? We are lucky to have many of the building blocks in terms of the investments and products to meet these retirement goals. However, one thing does stand out – usually a mix of products will do the job much better.

Meeting retirement goals

The shading above indicates how well the particular product (on the left) meets the retirement goal (on top).

What can we tell when we try to match up products or investments against these long term retirement goals? For one, it is clear that there are some goals where there is only one way to achieve them, and so we need to prioritise these products. E.g. meeting Healthcare goals through purchase of Hospitalisation and Surgery insurance, or maintaining Liquidity through Financial Investments.

However, there are also other goals, e.g. Final Bequests, where there are many ways to get there (such as using Term Life Insurance). Finally, there are goals, e.g. having a steady Income, which is better achieved using a mix of products like Annuities and Financial Investments.

This is really all about Product Allocation, or allocating between different products to meet a certain objective or goal better.

Product Allocation

What exactly is Product Allocation? Well, we are going to leave the details for a future post: Product Allocation – The Key to Personal Financial Planning. However, we can start by crediting Moshe Milevesky for introducing this concept.

Product allocation is not quite like asset allocation. In asset allocation, we allocate funds between different investments with different risks. E.g. safer bonds versus riskier stocks, but they fundamentally are financial investments which trade off price risk for return. In product allocation, we allocate funds between different products. E.g. insurance polices versus financial investments, which don’t have similar risks, and together, produce superior outcomes not possible with one type of product alone.

Previously, we have written about specific cases of product allocation between annuities and financial investments, so you can have a read to get the idea of it:

But keep an eye out on our next post on product allocation!