## Sunday, 13 September 2015

### Has an entire generation been ill-advised on Financial Planning? (Part 2)

In the previous post, I have talked about the steps to create our own insurance which has an investment component comprising 60% “CPF bonds” and 40% “STI ETF”. For this post, I will touch how it generates a better return.

Projected returns

From the SPDR STI ETF’s track record, the annualised return is 7.11% as of end August 15. While for the “CPF bonds”, we have to assume under two scenarios: i) 4% returns or ii) 5% returns. This is because while the Singapore government guarantees 4% for the CPF SA, the first combined \$60,000 yields an additional 1%. Also as some will purchase whole life when young (25 to 30), the voluntary contributions may result in “CPF bonds” that are likely to yield 5% instead of 4%.

Assume “4% CPF Bond return” scenario

The formula is simple where the weight of each asset class is multiplied by its returns and then added up to calculate the projected returns

Hence projected is 0.04*0.6 + 0.0711*0.4= 5.24%

However like most insurance products, despite the projected returns stated in the benefit illustrations (i.e. 4.75%), the actual returns we receive will be lower because of distribution cost.

Hence for the DIY plan, the annual projected returns is \$1200*0.04+ \$800*0.0711=\$104.88

The returns in percentage will be \$104.88/\$2153.60= 4.87%

Assume “5% CPF Bond return”

The projected return will be 5.84% and actual returns will be 5.43%.

This return is higher than the bonus projections of any whole life!

While people may note after the age of 65, there is no longer term coverage. A reason for it is because after 65, you would have accumulated more than \$100,000 in savings through CPF and STI ETF which can be withdrawn anytime. Furthermore, at the age of 65, it is likely there are no dependents/housing loan obligations. Therefore insurance for dependents is not required.

Back testing the strategy

Using the period of April 2002 (SPDR STI ETF’s inception) till now, and comparing between the returns of our DIY plan and whole life. The DIY plan has returned 5.24% annually. On the contrary, many whole life have difficulty meeting their projected returns [4.75% (from 2013) or 5.25%] stated on their benefit illustrations table.

Conclusion

So there you have it, a replicated DIY insurance plan offering a matching/better returns. This was achieved mainly through investing in AAA rated sovereign CPF bonds yielding a 4-5% annual return and equity investing through STI ETF.

Furthermore, it’s worth noting should Jerome fall in financial hard times, he has the option of cashing out the STI ETF proceeds anytime. Similarly, he could cash out his “CPF bonds” anytime if he is above age 55. This is unlike whole life where if we are to surrender our policy, it results in a drastic reduction of our cash bonus returns (probably in the region of 1-3%).

I have provided the projected return of this plan below. Do note this plan assumes that the policy starts from age 27. You may compare it to the benefit illustration tables of insurance products you will receive in the future but just remember the starting age will be different.