Finance Smiths

Personal finance apprentices-in-training

How much cash to hold in our portfolio?

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I have discussed the cash component of my portfolio in some detail in my previous posts but I have not dedicated an entire post about cash yet. Given that about one year has passed since we started seriously investing in Singapore in May 2015, it’s a good time to discuss in more detail the role of cash and the amount of cash we hold in our portfolio.

Why do we hold cash in our portfolio?

In my asset allocation post, I discussed how we hold cash for the three main purposes of Emergency, Spending and Investment. I will give an overview of how we have been using our cash for these purposes.

Emergency 

We have set aside Emergency cash holdings to be used in the event of financial emergencies. We have yet to experience these unpredictable and life-altering events in the past year but I should mention that the risk of retrenchment has increased. We try to exercise about twice a week to keep ourselves active and healthy in the hope that this reduces the risk of medical emergencies over time. So far, the draw down of our Emergency cash holdings has been minimal.

Spending

This is where we set aside cash for paying our monthly mortgage, credit card and travel expenses. The draw down of our Spending cash holdings has been much more frequent and significant. Our living expenses are higher than average and it’s been something we have been working on to reduce.

Investment

We hold quite a bit of cash for investing into ETFs and shares every month.  The draw down of our Investment cash holdings has the widest variations. When the markets are down like in Jan and Feb 2016, we use these cash holdings to make significant investments. When the markets recovered in Mar and Apr 2016, we didn’t use much of these cash holdings and allowed them to build up.
How much cash to hold in our portfolio? 

This is one of the most important questions we should ask ourselves when constructing an asset portfolio. It depends on so many factors that there’s no one-size-fits-all answer. I’m going to try and apply what I have read to our situation so you can have a real-life illustration of these factors.

Risk of retrenchment

Our salary is the main source of income that allows us to build up these three cash holdings. However, the risk of retrenchment affects the Emergency cash holdings the most. A good way to look at it is how many months can you live on the Emergency cash holdings (ignoring all other cash holdings) when you lose your job.

In our scenario, if we both lose our jobs at the same time (assuming no changes to lifestyle), our Emergency cash holdings can last for 6 months before it runs out. Of course, it’s more likely that we will adjust our lifestyle and start paying more of the mortgage from our CPF. This can probably stretch the Emergency cash holdings to 12 months.

Fixed and variable expenses

The amount of monthly fixed and variable expenses affects the Spending cash holdings the most. Due to our higher than average living expenses, we hold about 3 months worth of Spending cash holdings. Since this should continually be replenished by our salary, dividend and interest income, we don’t think it’s necessary to hold more than that especially if we have a sufficient Emergency Fund.

It’s important to assess how difficult it will be to reduce your fixed and variable expenses. The more flexibility you have in adjusting these expenses downwards, the less Spending cash holdings you have to hold. We have identified the areas in our fixed and variable expenses where we are working on reducing the amounts spent. This is a continuous process and a good exercise in budgeting.

How do you plan on investing during bear markets and downturns?

For any investor, it’s essential to have a strategy during bear markets and downturns. It’s even more important that you execute this strategy effectively when the time comes. Our strategy is to invest into ETFs and shares every month, less in good months and more in bad months. We try not to time the market but we do adjust the amount we invest depending on the market performance in the month.

This requires us to have sufficient Investment cash holdings to buy the ETFs and shares every month. It’s probably higher than average to allow us to execute our strategy of increasing these investments during bad months. Depending on the severity of the bear markets, the draw downs can be significant. More importantly, we don’t let these Investment cash holdings increase past a certain level to keep ourselves vested in the markets for the long run.

Ultimately, how much cash to hold in your portfolio becomes a question specific to your circumstances. I agree with the argument that for a couple at our age, we should aim to hold less cash and more equities since that should translate to a higher return over a long investment horizon. However, I also think that having a long investment horizon means we can afford to be more patient with our cash. We can take our time to deploy the cash slowly but efficiently. As such, we have a high regard for cash and continue to hold more of it where possible.

Which retirement scheme do I prefer?

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In my previous post, I gave an overview of my Superannuation in Australia and Central Provident Fund (CPF) in Singapore. This post will be about my personal opinion on which retirement scheme I prefer. It’s important to note that Superannuation and CPF serve as retirement funds in Australia and Singapore respectively where the cost of living, tax rates, lifestyle etc are different.

It can be difficult to compare these two retirement schemes on a level playing field. This comparison might not be fair but it will be based on my experience and views. At the very least, isn’t it interesting to read about how different retirement schemes measure up against each other?

Employer Contributions 

The purpose of retirement schemes is to provide you with income in retirement. The more funds you have in the retirement schemes, the more income you will receive when you retire and stop working. Employer contributions can go a long way in building up these funds especially when you can’t make as much employee contributions.

The current employer contribution rate is 9.5% for Superannuation and 17% for CPF. However, there is a monthly Ordinary Wage (OW) ceiling cap of S$6,000 for CPF i.e. the employer only needs to contribute 17% of your monthly salary up to S$6,000. The employer does not need to contribute 17% of your excess salary above S$6,000. I don’t think there’s such a cap on employer contributions for Superannuation.

This probably only makes a difference when you are a high income earner in Australia or Singapore. Given I have only been working for a few years in each country, this point goes to CPF for me since I had more employer contributions on an average salary.

Employee Contributions

There is no mandatory employee contribution for Superannuation but the mandatory employee contribution rate for CPF is 20%. I like how the Singapore Government is essentially forcing each employee to save for his/her retirement by contributing to the CPF. It might not be a bad idea since I chose not to make any contributions to my Superannuation.

However, it would be nice to have the choice of my employee contribution rate to CPF. After all, I might decide that having the cash on hand is more useful at the start of my career when I am anticipating future significant expenses. Although I agree that the Government should encourage employees to contribute to their CPF, I don’t agree with the current paternalistic approach to mandate a rate of 20%, which is even higher than the employer contribution rate. This point goes to Superannuation for me.

Flexibility of use

Superannuation can be used to cover life, disability, and income protection insurance premiums but there are not many other uses. CPF can be used for a variety of purposes – housing, investment, education, insurance and medical expenses. By allowing for greater flexibility in using CPF, this offsets the disadvantage of me having to make mandatory contributions to CPF.

Although you could make an argument that having so many uses for CPF detracts from its main purpose as a retirement fund scheme, it does come down to how you manage your CPF.

Superannuation is difficult to understand at the start but easy to manage once you get the hang of it. Once you start working after graduation and select a superannuation fund, ensure that the investment option is balanced or aggressive and the monthly contributions will take care of the rest.

The problem with CPF is that you really have to monitor how much of the OA you are using for housing, how much you can contribute to the SA and how much MA you have left for medical expenses.

Nevertheless, this point goes to CPF for me because it’s better to have more options of use for the retirement fund schemes. After all, you can always decide not to use your CPF for anything and just allow the balances to build up.

Growth of funds

This one is tricky. Superannuation works by dollar cost averaging into the units of a fund on a balanced or aggressive investment option i.e. growth by exposure to equities. You could replicate this by using the CPF Investment Scheme, which allows you to invest your OA and SA in a wide range of investments to enhance your retirement funds.

Both schemes require you to not attempt market timing by changing the investment options for Superannuation funds or buying & selling the investments for the CPF Investment Scheme.

I guess where CPF takes the point for this is that the interest rate on the SA can reach 4% to 5%. Even by not using the CPF Investment Scheme, effective utilisation of the SA can enable your retirement funds to build up quickly over time without taking on much risk.

Fees

Superannuation funds charge fees for maintaining your retirement balances and CPF don’t charge fees for the same service (unless you are using the CPF Investment Scheme). You could argue that Superannuation funds have to execute more monthly transactions (i.e. buying and selling of units) to justify the fees.

After all, CPF doesn’t have as many monthly transactions since interest only gets paid at the end of the calendar year. You do have withdrawals for other purposes such as housing and insurance but those can be automated and require less monitoring.

My view is that fees eat into the returns of all funds and CPF takes the point for charging little to no fees.

Access at retirement

This generally refers to when and how you can access the Superannuation or CPF. The conditions of access can be complex for both Superannuation and CPF. For a simple comparison, Superannuation can be fully accessed at age 60 but CPF can be partially accessed at age 55 and fully accessed at age 65. More importantly, the entire amount of Superannuation can be withdrawn but CPF can only be withdrawn as a monthly payout once you hit the preservation age.

FYI, my view is that the preservation age for retirement schemes in most countries are likely to get higher over time. I would think this applies to both Superannuation and CPF i.e. I have no idea how old I would have to be to access my retirement funds.

As much as I think it’s a good idea not to allow for retirees to withdraw the entire amount of CPF at one time, this should be a choice that they have. Again, I don’t agree with the paternalistic approach that the Singapore Government has taken on restricting retirees’ access to their own retirement funds. Hence, point to Superannuation for me. It might be a better approach for more personal finance education in schools and companies to empower everyone with the ability to make good financial decisions.

Conclusion

I must emphasize that you could reach a different conclusion even after assessing the same factors. In my case, I find that CPF is my preferred retirement scheme. It allows for me to build up retirement funds quickly from higher employer and employee contributions. This is especially effective when I have not been working in Singapore for the initial few years of my career. CPF also gives me more options in utilising the funds for other purposes and I find the flexibility useful as long as I have the self-discipline and knowledge to manage this.

Retirement – Superannuation vs CPF

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My post on What are Retirement Funds is the second most read after the post on Monthly passive income hits S$1,000. It does seem like personal finance topics like passive income and retirement continue to be among the most popular.

I thought it would be interesting to have a post about my experience with Superannuation in Australia as a retirement fund scheme compared to Central Provident Fund (CPF) in Singapore.

Upfront disclaimer – I can only compare my experience with Superannuation during my 4 years working in Australia vs CPF during my 3 years working in Singapore. I’m aware this is an insufficient time frame for the benefits of each retirement fund scheme to realise but this is just my opinion based on how each system has worked out for me so far. The facts may also not be fully accurate as I am writing some of them from memory.

Overview of my Superannuation in Australia

When I started working in Melbourne after graduation, my employer contributed 9% of my salary every month to a Superannuation fund of my choice. The employer usually has a preferred Superannuation fund and I chose that because I had no knowledge of any Superannuation fund. I tried reading up but was overwhelmed by the number and range of Superannuation funds available. To be fair, it was my first full-time job in Australia and I was coming from Singapore where everyone only had one retirement fund that contributions go into i.e. CPF.

I decided not to make any voluntary contributions because I was unsure of how long I will be living in Australia. The Superannuation fund had 4 main investment options – cash, conservative, balanced and aggressive. I selected the aggressive investment option since it had the highest return over the long term due to the biggest exposure to equities.

This meant that the monthly contributions by my employer went towards purchasing units in the aggressive investment option of my Superannuation fund. It’s essentially a dollar-cost averaging approach and the valuation of the units change depending on the value of the underlying assets of the fund. Hence, the value of my retirement funds in Australia could vary significantly with each year since it depends to a large extent on the performance of domestic and international stock markets.

Life, disability and income protection insurance premiums were also deducted from my superannuation fund monthly. The coverage amounts were good relative to the amount of premiums paid. This is a benefit from selecting the preferred Superannuation fund of the employer.

However, there is a monthly account maintenance fee deduction and the amount can vary depending on whether the investment option is cash, conservative, balanced or aggressive. Superannuation fund fees can really eat into its returns if you are not careful.

After I moved to Sydney and started working for a different employer, I decided to roll the holdings in my previous Superannuation fund in Melbourne to the new preferred Superannuation fund in Sydney. This can be a hassle when you think about the number of times a person can change jobs over the span of a career. It’s probably the reason why Lost Superannuation is such a big issue in Australia since it can be difficult to keep track of all of your Superannuation fund holdings.

Overview of my CPF in Singapore

When I moved back to Singapore, I had to leave my Superannuation funds in Australia since I can’t withdraw it due to my status as a Australian permanent resident. Before leaving, I changed the investment option of my Superannuation fund to cash to reduce volatility in the value. It will grow much more slowly over time but made the most sense for me since there are no longer any monthly contributions to my Superannuation fund.

I had previously written about how I manage my CPF in Singapore. Basically, a Singapore citizen or permanent resident employee has only one retirement fund in Singapore i.e. CPF. There are no other choices available, which is a lot less confusing compared to Superannuation. In my case, the employer contributes a higher percentage (17%) of my salary to CPF. However, I have to contribute an even higher percentage (20%) of my salary to CPF. This is mandatory and I don’t have any choice in the matter unlike with Superannuation where I can choose not to contribute and only have my employer contribute.

As you can see, these contributions are significant (37% of my salary) and they are split into 3 accounts. Ordinary Account (for housing, insurance, investment and education), Special Account (for old age and investment in retirement-related financial products) and Medisave Account (for hospitalisation expenses and approved medical insurance) in the percentages of 23%, 6% and 8% respectively.

The interest rates earned on the OA, SA and MA are 2.5%, 4% and 4% respectively. However, there is an extra 1% interest paid on the first S$60,000 of my combined balances (with up to S$20,000 from my OA). This means I can earn up to 3.5%, 5% and 5% on my OA, SA and MA. The interest earned is credited at the end of each calendar year.

You should be able to observe the big difference in how my Superannuation fund and CPF balances grow. My Superannuation fund return in the aggressive investment option depends on the performance of stock markets while my CPF return depends on the setting of the interest rates. The former mainly relies on the effectiveness of the dollar-cost averaging approach to equities while the latter mainly relies on the interest rate environment.

These overviews are necessary as an introduction to my next post on whether I prefer Superannuation or CPF as a retirement fund scheme. It should be an interesting comparison based on my experience and even I would like to know which one I prefer at the end of the post.