SINGAPORE (Mar 26): Animals are born free. In the first few minutes of life, they learn to crawl. Next, they take off into the woods. And soon, they will hunt for themselves.

Men are born with ransoms on their heads. Whether they like it or not, they have to drag themselves to work to earn their keep. They battle daily to get to work, to work, and to come back from work. While they do battle at work, their children do battle at school.

How much does a man need to set himself free? In Singapore, it costs at least $1 million.

If one puts $1 million into fixed deposits that give 1% interest income per year, this translates into a monthly income of $833, or $28 per day. This figure is similar to what the average folk earn in Egypt or Laos. If one lives in Singapore, then it means plain porridge every day with a fried egg thrown in during Christmas.

If one takes the $1 million and invests it in property and collects rent from it, earning a yield of 2%, this works out to be $20,000 a year, or $1,666 a month. This figure is what the average folk earn in Vietnam or Nicaragua. Life on a beach in Central America might not be a bad idea. However, if one insists on Singapore, then one has to settle for homecooked meals and the occasional excursion to Johor for satay.

It looks like $1 million does not amount to very much these days, unlike in the good old days. They don’t mint them like they used to. That is why I call today’s millionaire a “poor millionaire”.

Is there a better way? Of course, there is. First, one has to understand that the equity asset class gives the best returns in the long term. Over the last 100 years, returns from stocks have beaten those from bonds, properties and commodities.

To make that $1 million work the hardest, there is little option but to make a full allocation to equities. And to make it work even better, the equities should be invested using the value approach. The value approach involves buying stocks that are undervalued based on their earnings, dividends and net asset.

Using this approach, the investor can expect to earn long-term average returns of 10% per annum. Since stocks are volatile and returns vary year to year — and in some years, negative returns can be expected — the investor cannot just withdraw $100,000 (10% of $1 million) from his portfolio every year. If the market corrects severely, and he makes that withdrawal, the resulting lower base does not get the full benefit of a stock market rebound.

Based on historical results, it is best to withdraw not more than 5% of the initial investment amount. This 5% is called a safe withdrawal rate.

In this case, $1 million invested using this approach would allow the investor to withdraw $50,000 a year, or $4,166 per month. That exceeds many other asset classes. And the bonus is, since the long-term expected returns are 10% per annum, the investor has an additional 5% to reinvest after using the first 5% for his expenses. The reinvested 5% over the long haul, coupled with the overall compounded return of 10% per annum from a basket of value stocks, will result in a substantially large pool later. With this enlarged pool, larger amounts of expenses can be supported.

Let’s illustrate with a simple example. Ah Beng retires with $1 million and invests the entire sum in a basket of value stocks. He withdraws 5% of the $1 million ($50,000) for his expenses every year for the next 10 years. As the long-term return is 10%, he gets to “save” an additional $50,000 every year for the next 10 years. If we use a financial calculator to compute the size of his portfolio on the 10th year, it is exactly $1,796,871. If he so chooses, he can withdraw 5% of that figure from Year 11 onwards. His withdrawal amount that used to be $50,000 a year can now be $89,000 a year.

The result is astounding, and beats a lot of other traditional approaches. The key reason for that is because it makes full use of the returns from the equity asset class through value investing.

At Aggregate, we use this approach for our investors to fund their retirement. So far, we find this method works well not only in terms of covering a retiree’s expenses but also growing his nest egg.

www.aggregate.com.sg

This article appeared in Issue 823 (Mar 26) of The Edge Singapore.

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