It might still be many years before I get to retire.
However, it is important to get started early for time to be on your side (think effects of compounding).
Let's do a simple exercise here.
Based on national statistics, the average monthly expenditure per member of a Singapore household is $1,628 in 2018. Assuming an inflation rate of 2%, this figure will be $2,419 in 2038 (which is just 15 years away).
Now, I'm sure many of us have heard about the 4% withdrawal rate (basically a safe retirement sum will be an amount which 4% of it could cover your annual expenses). Based on the monthly figure of $2,419, the annual expenditure will be $29,028. And hence the retirement sum to work on will be $725,700.
For simple understanding, here is a table to show you the initial amount you need in different circumstances (no of years to retirement and expected annual rate of return in your investment)
For example, if you are targeting to hit $725,700 in 10 years' time with an expected annual return of 5%, your initial sum will be $445,516.85. If your portfolio does not currently have this value, you will then have to either work longer or achieve a higher annual rate of return in your portfolio.
As rate of return is not something that we can control with ease, the easiest way to ensure that you can retire in time is to start early. Notice that the initial sum differed by quite a bit when you increase the number of years from 10 years to 15 years from the above table. So the easiest thing you can do for your retirement today is to start building your retirement sum now. The earlier you do it, the easier it gets.
While rate of return might not be something we can totally control, that doesn't mean that there is nothing we could do to boost our chances of getting a higher rate of return for our portfolio. In fact, there is exactly a proven trick to achieve a higher rate of return for your portfolio without changing the constituents of your portfolio.
That is to do Value Averaging (VA).
To the regular readers, you might already be aware that I regularly Dollar Cost Average (DCA) my SRS funds into the S&P 500 index. Moving forward, I will continue to do so but do Value Averaging (VA) into my regular portfolio (the one which I do quarterly updates on).
So how does value averaging work? Well, it works like Dollar Cost Averaging. Instead of putting a fixed sum of money over the intervals, you ensure that your portfolio hits a certain value over the intervals.
For instance, if the target for your portfolio is to grow by $2,000 every month, your monthly contribution into your portfolio differs according to how your portfolio performs. If your portfolio increases by $1,000 through investment returns, you will only contribute $1,000 for that particular month. Similarly, if your portfolio decreases by $1,000 in a particular month, you will contribute $3,000 to make up for the difference and ensure that your portfolio value still grows by $2,000.
Why value averaging then? Well, because it's a proven methodology to provide a performance advantage over Dollar Cost Averaging. You may like to check out this financial literature here which cover multiple simulations to prove this point. In almost every situation, Value Averaging always results in providing a higher rate of return.
However, it does have its cons.
One, if the market is bullish for a few years consecutively, you are going to end up investing a lesser amount of money than you should have. So while you might achieve a higher rate of return for your portfolio, the terminal value of your portfolio will be lesser than what you should achieve with Dollar Cost Averaging (DCA).
Two, if the market has a tremendous drop, you might not have enough funds to make up for the difference and ensure that your portfolio continues to grow by the amount it should have in terms of value.
So now that I am doing Value Averaging to achieve my ideal retirement sum, how do I try to overcome the cons?
On the first con, nothing much. I am of the opinion that it is possible the market will have some down years in the near future (5 years or less) and that is where Value Averaging could help me invest well. In the long run, I am positive the market will always be on an uptrend. I ran this poll on my subscribers' thoughts about a recession in the U.S in the next two years. 121 responded with a majority believing that a recession will happen in the next two years. If the majority is right, I might be able to benefit from my strategy.
On the second con, by ensuring that I could cater for the worst annual drawdown for my portfolio as much as possible. I ran my portfolio via portfoliovisualizer.com and here are the annual returns for the past 8 years (that's as far as the historical data goes based on my portfolio constituents.
(Source: https://www.portfoliovisualizer.com) - based on an arbitrary initial sum of $10,000
In the worst year (2022), the return was -26.96%. Assuming an annual target growth rate of 7% for my portfolio, I need to be prepared to be able to put in an annual contribution equalling almost 34% of my investment portfolio in any given year. This might sound like a big number, but it's definitely doable when your portfolio sum is modest (like what I am having now). Once my portfolio grows to a certain size, I will also shift gears to invest in perhaps bonds, properties, funds etc. When that happens, the drawdown will not be as bad as this and I will definitely not be expecting to prepare an annual contribution equaling to almost 34% of my investment portfolio.
I hope this article has been helpful to provide some snippets of my thoughts on how I build my portfolio. If you like to join the community to do polls and feel the pulse of the market, do join my Telegram channel.
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