Financial Planning with M Farhan

Some pointers to avoid being pushed or mis-sold an insurance product… (part 1)

It seems I have become a magnet for people enquiring on being pushed or mid-sold insurance products, occasionally getting such enquiries.

So I thought perhaps I should write some pointers for customers out there:

1. Savings plans may not be for you

Savings plans, though seemingly safe, may not be for you.

“But savings is good for you, for future needs.”

Yes, it is good.

“Plus, there’s no investment risk..”

Yes, it would seem so. So where does the problem lie?

Premium commitment. Often, customers are led to sign up a 20-year or 25-year plan. (Can you commit that long?)
Inability to withdraw when needed. While it is a strength to discipline yourself to save regularly, it is also a weakness. (Is liquidity a concern for you, especially for the next 5 to 10 years?)
High cost of early surrender. Life can be uncertain. Your commitment to the plan can be affected. (Will you be able to sustain the plan or flexibility to adjust is an important consideration? Is liquidity, again, a concern?)

I will continue in 2 or 3 subsequent posts touching on the other types of insurance products that can be mis-sold or pushed to the customers to buy.

What is a hedge feature in a fund?

When investing in unit trusts or investment-linked policies (ILP), you would find in the list of fund choices fund names with the term “SGD-H” or “Hedged SGD”. What does this mean?

A hedge. What does it mean in investment? (Image for illustrative purpose only.)

A hedge is an investment to reduce the risk of adverse price movements in an asset. Normally, a hedge consists of taking an offsetting position in a related security.
What is a hedge?, Investopedia.com

It could look something like: SGD-H. This means that the fund’s underlying exposure is hedged to the SGD. When you buy a unit trust with a SGD-hedged share class, you are in effect hedging your exposure (from the fund’s underlying exposure) to the SGD. The fund you purchase may be invested in the European credit markets, whereby securities there are denominated in the EUR. Thus, your currency risk as a Singapore-based investor would be to the EUR, and the value of your investment would be exposed to the fluctuations of the EURSGD exchange rate. By adopting a SGD-hedged class of the fund, you can lower your risk of a weakening of the EUR against the SGD eroding your investment returns from the European credit market.
Unit Trusts: Differences Between The Various Share Classes, Fundsupermart.com.

For Singaporean investors, a SGD-hedged fund allows you to invest in a fund that is denominated in another currency, while lowering your risk of the currency weakening.

Should you invest in such a fund? It depends on your objective, your risk appetite and other preferences and considerations. It is best to discuss with your financial planner/advisor before choosing such a fund.

“How can life insurance pay out more than the person has put in?”

The following is my answer to a Quora question: “How can life insurance pay out more than the person has put in?”

From an individual perspective, the insurer has paid out more than the premium if the claim was early. From the insurer’s perspective, they have paid out one claim for a single policy, but have earned from tens, even hundreds, of thousands of other policies that are still premium paying. This is the benefit of portfolio costing. Also, when insurers take in all that premium from their policyholders, they invest it out for further returns so that in the event of a spike in claims, the insurer is not financially compromised.

Terence Kenneth John Nunis

[Shared with permission from: https://terencenunisconsulting.blogspot.com/2020/06/quora-answer-how-can-life-insurance-pay.html?m=1 ]

“Should you add international bonds to your portfolio?”

The following is my answer to a Quora question: “Should you add international bonds to your portfolio?”

That really depends. Bonds are used to balance out a portfolio, diversify it and spread risk. When it comes to international bonds, particularly long-term bonds, you have to consider currency and political risk. You can mitigate the latter by putting your funds in rated investment grade sovereign bonds or corporate papers. It is difficult to mitigate against the former. For example, consider how it is from my perspective in Singapore. 20 years ago, the US Dollar to Singapore Dollar was US$1 to S$1.60. Today, it is US$1 to S$1.30. I am old enough to remember a time when it was close to US$1 to S$2. If I put my money in a 30-year Treasury bond, what would I expect the exchange rate to be in 30 years’ time? Would I earn enough to overcome that exchange rate exposure? These are major considerations in how I balance my portfolio.

It is an advantage as well as a disadvantage that international bonds are not correlated to the domestic bond market. It means that a drop in the local bond market does not necessarily mean a drop in my international bond portfolio, which balances it out. But it also means that a domestic rally would not be a rally across all my debt instrument portfolio. International bonds are an excellent way to diversify your portfolio, and mitigate from local political risk. But they should be one component of a balanced, diversified portfolio, not a major part of it.

Terence Kenneth John Nunis

[Shared with permission from: https://terencenunisconsulting.blogspot.com/2020/06/quora-answer-should-you-add.html?m=1 ]

Finding a balance and diversified portfolio is usually achieved through experience and diligent study of the market.

One might come across financial planners/consultants who would favour certain funds which seemingly painted as good, such as giving high dividends. Yet the graph on the fund factsheet would indicate otherwise.

It is always important to remember the objective of the investment, and a good financial planner/consultant should advise you towards that objective.

He should be able to make a decisive call, such as when his previous fund recommendation is not performing as expected, and hence recommending fund switch or premium allocation redirection with justification.

Best hedge against inflation?

The following is my answer to a Quora question: “Which of the following is best hedge against inflation? Land, investment, real estate, precious metals, or a mutual fund invested heavily in large capital stock market?”

Image for illustrative purpose only.
Photo by Sergio Roberto Bichara from FreeImages

The best hedge against inflation is property and REITS. The price of homes and property rise with inflation because their prices are also affected directly by inflation. REITS will grow due to the increase in value of the underlying asset.

Gold, commodities and precious metals tend to be a good hedge against inflation, but only as a broad basket of investments. Individual commodities may not perform as well. Gold is also an excellent hedge against political risk.

Debt and equity instruments are poor hedges against inflation. Equity instruments such as stock will rise eventually because that is the market trend, but in the short term, may not keep up with the sudden increase in inflation. Debt instruments, which include sovereign bonds are terrible hedges against inflation since the yield is fixed over the term. They are used to balance a portfolio, not hedge against inflation.

Terence Kenneth John Nunis

[Shared with permission from: https://terencenunisconsulting.blogspot.com/2020/06/quora-answer-which-of-following-is-best.html?m=1 ]

“Do high yield bonds have a high default rate during a recession?”

The following is my answer to a Quora question: “Do high yield bonds have a high default rate during a recession?”

Yes. These bonds have a lower credit rating, meaning they are not investment grade bonds. These bonds are not rated corporate papers, or sovereign bonds. Their underlying issuer either has a weak financial position, or is already heavily leveraged. To attract investors, they have to offer a higher yield. Most such bonds are essentially junk bonds. Let alone a recession, a high yield bond from a start-up might default simply because that start-up missed a fund-raising target. These are not debt instruments for the faint-hearted, or those with liquidity exposure.

Terence Kenneth John Nunis

[Shared with permission from: https://terencenunisconsulting.blogspot.com/2020/06/quora-answer-do-high-yield-bonds-have.html?m=1 ]

To add: fund houses seem to shift focus on investment grade bonds, especially in the current economic climate.

Investors should review their investment portfolio, and look into the need to reallocate funds to tide over the next 6 months, while keeping in mind the investment objectives.

“What are the factors to consider before you invest, especially in long-term investments?”

Key takeaways:

Know your risk tolerance
How much liquidity do you need? When do you need it?
How adventurous are you in terms of asset classes? (Risk profile and preference)
What kind of returns would you like to aim for?

The following is my answer to a Quora question: “What are the factors to consider before you invest, especially in long-term investments?”

Here are a few points of consideration. They are not exhaustive. When we talk about long term investment, I am assuming we are looking at a 15-year to 20-year horizon, at least.

Firstly, you need to know your risk tolerance. How much are you prepared to lose? How much of a drop in value can you tolerate? This determines the weightage of your portfolio, between debt and equity.

Secondly, how much liquidity do you need? And, how fast do you foresee yourself needing this liquidity? This determines the asset classes you invest in, and the weightage. For example, you may like property, but property is not liquid. This means you need to consider some of your funds in more liquid asset classes, such as money market, or stocks.

Thirdly, how adventurous are you in terms of asset classes? Do you have a preference? Is there something that interests you? This determines whether you put your funds into something complex like derivatives, or something exotic like precious metals, or something new like cryptocurrency.

Finally, you need to determine what sort of return you would like to aim for at the end of that investment period, the milestones in between, the investment vehicle, and how involved you want to be.

It is a no brainer that you should run investments through a vehicle such as a company or a trust. This mitigates your tax liability. It protects your investments from adverse events such as personal bankruptcy. It might even be preferable to have multiple such vehicles. The most important consideration is in finding the right financial advisor; the right property agent, if required; the right fund manager; the right tax accountant; and the right investment banker. You cannot hope to know everything and do it all yourself.

Terence Kenneth John Nunis

[Shared with permission from: https://terencenunisconsulting.blogspot.com/2020/06/quora-answer-what-are-factors-to.html?m=1 ]

“I still need growth on my investment for retirement. Should I avoid bonds?”

The following is my answer to a Quora question: “I still need growth on my investments for retirement. Should I avoid bonds?”

That really depends. As you age, and seek growth, you may give greater weightage to equity instead of debt instruments in your portfolio. This should have the involvement of your financial planner to decide on your weightage. However, you should also be aware that debt instruments such as bonds mitigate against volatility since their return is stable. Whilst equity gives greater potential returns, they are also more volatile, and should the market drop, the value of your portfolio will be affected.

We have bonds in our portfolio, particularly in anticipation of market turbulence, to mitigate against this drop in portfolio value when stocks tank. It saves you a heart attack. A person further away from retirement has time for the portfolio to claw back value. A person retiring a year later does not have that luxury.

Considering a projection of how the market will perform within that period of time to your retirement, you may reduce your bond holdings and increase weightage to equity, but never eliminate bonds from your portfolio entirely. They have their place in every balanced investment portfolio.

Terence Kenneth John Nunis

[Shared with permission from: https://terencenunisconsulting.blogspot.com/2020/06/quora-answer-if-i-still-need-growth-on.html?m=1 ]

On a similar note, some consumers rely on retirement saving plans from insurance companies for their retirement funding needs.

While retirement plans offer some guarantee and stability, they do not offer much growth.

Striking a balance between stability and growth is key, and best with consulting a financial consultant/planner.

Understanding Whole life insurance

When buying personal life insurance, you’d be introduced to Term life insurance, Whole life insurance, Endowment/savings plans, as well as Investment-linked policies.

Each product type has its purpose, advantages and disadvantages.

So what is Whole life insurance?

Whole life insurance provides coverage for the life of the insured. In addition to paying a death benefit, whole life insurance also contains a savings component in which cash value may accumulate. These policies are also known as “permanent” or “traditional” life insurance.
Whole Life Insurance, Investopedia

Key benefits of Whole life insurance:

Pay premium for limited term, lifetime coverage (till age 99)
- Do note that in Singapore, for most (if not all) whole life insurance policies, Total & Permanent Disability (TPD) coverage terminates at age 65 or 70 of the life assured.
Whole life insurance policies generally cost more than Term life insurance policies as part of the premium is invested to build cash value.
Policy loan is allowed.
- Do note that it is to be repaid with interest.
Early termination would incur early surrender charges, which may result in losses.
- If you have to cut down on premiums, you may consider converting to a Paid-up term policy. (I’ll touch on this in a different post.)

[Read more at: Understanding Whole Life Insurance, A Beginner’s Guide To Participating Whole Life Insurance VS Investment-Linked Policies (ILPs). I’ll be writing on ILP in a subsequent post.]

[Important disclaimer: the objective of this post is to provide a brief explanation of Whole life insurance for ease of understanding. Further details should be discussed with your financial consultant/planner, especially with regards to your own policy and your financial needs analysis.]

Save to invest

While this shouldn’t deny the need to save, know why you’re saving: for a future need and for growth.

Save to save enough for Emergency Fund and short term needs. Invest for future needs and growth.