Finance Smiths

Personal finance apprentices-in-training

Mar 2016 Financial Update – P&L

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I’m going to try and start a regular series of Financial Updates, probably monthly for now to see if I can maintain it. It will be structured in a Profit & Loss (P&L) and Balance Sheet (BS) style in what I hope is a clear and concise manner. I will go in the following order: Income, Expenses, Assets and Liabilities and summarise the main points of consideration that impact each item. This post will cover Income and Expenses while the next post will cover Assets and Liabilities.

Income

Salary income for my wife and I have been consistent so far for the 2016 year. However, the bad economic times have impacted my wife’s banking industry more than my accounting industry. The risk of retrenchment has increased for both of us (maybe more so for her) and we do not expect year end salary increases or bonuses.

We have always been preparing for possible job loss given my experience with unemployment and underemployment after graduation in Melbourne. In fact, my wife faced her own underemployment and unemployment issues after working for two years in Melbourne. I don’t think I have mentioned this before but that’s actually the reason we moved to Sydney. Although working overseas and facing such situations have taught us to depend on ourselves and plan for the worst, it’s another thing to have to face this increased risk of retrenchment again.

This is the first year I’m recording our monthly dividend and interest income received. The dividend amounts are greater than the 2015 year because we have bigger ETF and Share portfolios but there have been cuts to the dividends received from certain companies we are invested in. We tried to make up for it by reorganising our bank accounts and credit cards to increased the interest earned. As our strategy is to try and invest every month into ETFs or Shares (less in a good month and more in a bad month), we expect the monthly dividend income to increase over time. We plan to increase our cash holdings in preparation for the increased risk of retrenchment, which means that  the monthly interest income should also increase over time.

We are on the search for other income sources as we currently rely on 3 income sources – salary, dividend and interest. It would be good for us to develop at least one more income source if possible but this will take a lot of time and effort.

Expenses

Our biggest expense continues to be the mortgage payment. Staying in an apartment in the East is certainly expensive but we are closer to my wife’s parents and it’s convenient for all of us to drive in to the city for work together. It’s also nice to have family around nearby after being overseas and home-cooked food for dinner is a big plus after a long day’s work.

I will run through the rest of the expenses in a descending order: Travel, Dining, Shopping, Apartment Maintenance, Groceries, Transport, Mobile & Broadband & Cable TV and Utilities.

I must admit that Lifestyle Inflation is a real problem for us. Although our incomes have gradually increased over the years, the same thing has been happening with our expenses as well. We are more willing to spend on taking taxis after work, eating out at restaurants, short-haul & long-haul holiday vacations. It might be the additional stress at work or just having to deal with more issues in life as we grow up but it impacts how much we spend to make ourselves feel better.

With the bad economic times and increased risk of retrenchment, we are taking the opportunity to re-evaluate our expenses and find ways to reduce them. For this to work, we will have to be disciplined in making gradual changes to our spending patterns to make the reductions more permanent.

How we manage our Retirement Funds

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In my previous post, I wrote about how we distinguish between Financial Independence Funds and Retirement Funds. Although their purposes are not mutually exclusive, it’s the timeline of drawdowns that differentiates the two. Before age 65 – 70, we intend to rely on our Financial Independence Funds heavily to enjoy “financial freedom”. After age 65 – 70, we expect to rely more on our Retirement Funds to enjoy “retirement”. As such, the management of our Retirement Funds is something we do in the background now for future use.

Weekend trip to Penang

By the way, I went to Penang for the long weekend with my wife and enjoyed the great food, street art, sights and sounds etc. I decided to go with one of the most famous street art piece in Penang as the picture in this post just for me to remember how much fun we had!

Monthly CPF contributions

Anyway, back to how we manage our Retirement Funds. Every month that we are employed, our employers contribute 17% and we contribute 20% of our salary (both compulsory) to our Central Provident Fund (CPF). As an introduction, CPF is a comprehensive social security system that enables Singaporeans to set aside funds for retirement and addresses healthcare, home ownership, family protection and asset enhancement. The contributions are allocated across the 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. These percentage allocations of the contributions change over time.

As you can see, the Ordinary Account (OA) and Special Account (SA) receives about 29% of our monthly salary and that is a significant amount. This means that our Retirement Funds grow consistently as long as we remain employed, which continues to be a working assumption for now. If unemployment ever happens to us, the duration will determine the extent of the impact to our Retirement Funds and we will continue to monitor this.

Drawdown of OA

We use some of our OA for our housing loan i.e. we pay the monthly mortgage amount in cash and OA. The percentage split changes once in a while depending on the asset allocation. Our target asset allocation for Retirement Funds is 20%. When the asset allocation starts to differ significantly from 20%, the main mechanism we use to bring it back to 20% is to increase or decrease the withdrawal from the OA for the housing loan. That being said, we only make the adjustment when the differential percentage is big and this does not happen often.

Cash top-up to SA

We contribute cash to our SA as a top-up and this qualifies for tax relief. There are many valid arguments for and against contributing cash to our SA. Increasing our Retirement Funds and decreasing our tax liability are the main benefits of making the cash top-up. Losing liquidity especially in bad economic conditions like now can be damaging since there is a higher risk of retrenchment and we might need the cash if it happens. As such, the way we do it is to make a monthly contribution of S$100 each to our SA at the end of each month of work.

This still increases our Retirement Funds (albeit at a slower pace) and the tax relief is applicable since we are only doing the cash top-up for every month of work. Most importantly, we don’t lose as much liquidity since the monthly contribution is small compared to our monthly salaries and it will stop if retrenchment is to happen. This is another mechanism we use to keep the asset allocation for Retirement Funds to 20% since we can increase or decrease the monthly cash contribution to our SA. However, this is usually our last resort since any changes to the cash top-ups to the SA is permanent and we try not to adjust the monthly cash contribution.

Transfer from OA to SA

Our target asset allocation for Retirement Funds is 20%. Once it starts to exceed 20% significantly, we transfer a certain amount of funds in our OA to SA to lock them in as Retirement Funds. The interest rate on the SA is higher than the OA, which means the effect of compounding on the SA is greater than the OA. However, we can’t access the SA for any other purpose and we only do the transfer when we can confirm that the excess OA can be locked in as Retirement Funds in the SA.

This transfer from our OA to SA is irreversible. It doesn’t change our asset allocation for Retirement Funds and is not one of the mechanisms we use to keep the asset allocation to 20%. It doesn’t happen often and the transfers are not big amounts given that we are still young and depend on our OA for the housing loan. However, I anticipate these transfers to increase in frequency and size as we get closer to age 65 – 70.

What are Retirement Funds

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As an accountant, I find the P&L approach towards my Income & Expenses and the BS approach towards my Assets & Liabilities to be an effective way to approach my personal finances. After all, the numbers don’t lie and are less open to interpretation. Every month, some of our income goes towards managing our expenses and reducing our liabilities, while the remainder of our income goes towards increasing our assets. However, there is a portion of our monthly income that we never receive as cash and this refers to the Central Provident Fund (CPF) contributions from our employers and us. These contributions get allocated directly to the Ordinary Account (OA), Special Account (SA) and Medisave Account (MA).

CPF is one of those topics that is almost always going to be mentioned in a personal finance blog. There is plenty of online content discussing CPF’s merits and demerits. I reckon it is more useful for me to write about how CPF fits into our asset portfolio. This is important for us to understand considering how a significant portion of our monthly income is allocated as CPF contributions.

How do we view our CPF and Investment Portfolio?

We view the OA and SA as retirement funds (focus of this post) and the MA as medical funds. The purpose of our investment portfolio consisting of the ETF, Share and Other portfolios has always been to be a tool for us to achieve financial independence. This should allow us to focus on work activities that are rewarding & fulfilling and leisure activities that are fun & enjoyable without having to worry about money. This means that the investment portfolio should really be considered as financial independence funds. We tend to view this separately from the retirement funds.

What are Retirement Funds (OA and SA)?

If you think about it on a timeline basis, the financial independence funds are likely to be used more heavily until we are age 65 – 70, since we can still be active in our work and travel. After that, the level of work and leisure activities are likely to start dropping off. Although we expect the remaining financial independence funds to still have a key role to play in our retirement after age 65 – 70, this is where the retirement funds (OA and SA) really step up. In our view, retirement funds (OA and SA) offer a basic standard of living i.e. they should cover our monthly fixed and variable (discretionary) expenses. The rest of our monthly variable (non-discretionary) expenses should be covered by our remaining financial independence funds.

How we allocate funds to the OA and SA?

I have added an additional page (Asset Allocation) to the blog that should provide a good overview of our current asset allocations. The target percentage for the retirement funds (OA and SA) is 20% and the current percentage is about 17%. Since there are monthly contributions to the OA and SA as long as we work, these balances should increase gradually over time in tandem with the rest of our assets. The main considerations are for us to manage the draw down of the OA for our housing, the cash top-ups to the SA for tax relief and the transfers between the OA and SA. I will discuss these issues in the next post.