Instead of worrying about the return on your investments, here's why you should focus on saving more money instead.
Many Singaporeans worry about the returns on their retirement fund, and whether they are high enough. That makes sense, but on a more practical level, it pays to focus on how much you save. This is something you can control, and which ultimately makes a bigger difference in the long run.
Why the Amount You Save Matters More Than the Returns
Whether the returns on your retirement fund are high or low, they ultimately have less impact compared to the amount you manage to save. For example, say you are able to save S$12,000 in your first year, and the return for that year is 7%.
The returns contributed S$840 (7% of S$12,000) towards your retirement, whereas the amount saved contributed S$12,000. It is that simple.
Let’s look at a longer term example. Say you save just S$4,800 a year, but manage to get a fairly high return of 9% per annum (perhaps you relied purely on a single insurance policy and nothing else).
At the end of 10 years, you would have around S$78,500, compounding at 9% per year.
On the other hand, let’s say you save S$12,000 a year, but have a return of just 3% per annum. At the end of 10 years, you would have around S$141,200.
(Note: for simple compound interest calculations, you can use this online calculator)
Besides this straightforward reason, there are some other factors as to why you should pay more attention to the amount saved:
- You have more control over contributions than returns
- Returns can fall drastically toward the crucial moment
- Higher contributions often mean less stressful investment choices
You Have More Control Over the Contributions Than the Returns
You cannot really control the returns on your various assets; the best you can do is try to predict those returns (and often with questionable accuracy). What you can control, to some extent, is the amount you contribute to your retirement fund every month.
One way this is important is with regard to your investment horizon (i.e. how long you are investing). If you start saving for retirement late - say at age 45 - you may be worried about having enough once you’re 62. Now you can’t control your investment returns, but what you can do is contribute more aggressively in order to make up for the shorter horizon.
For example, say you contribute S$12,000 a year, at an annualised return of 7% per annum (for the lay person that’s an ambitious return to aim for, by the way). You have a horizon of 17 years. At the given rate, you would have around S$393,000 by the age of 62.
However, let’s say you tighten your belt a little, and just contribute another S$500 a month (bringing contributions to S$18,000 a year). You choose a simple, low-risk investment with 3% returns per annum. After 17 years, you will have S$402,500 by the time you retire.
You’d still beat higher returns with higher contributions. But the best part is, you have control over these contributions. Just by setting aside more, you do more to help your retirement than by pursuing fancy investment options or taking on big risks.
Returns Can Fall Drastically Towards the Crucial Moment
Every few years, financial markets tend to crash. We saw this with the Asian Financial Crisis in 1997, the Dot-com Bubble in 2001, and the Global Financial Crisis in 2008/9.
There is no guarantee that, as your time to retire draws near, you will be one of the unfortunate people whose assets are affected by crashing financial markets. You might find, as you approach the last five or six years before you retire, that you have poor or even negative returns.
This is why as you near retirement, most Financial Advisors will insist you shift toward safer assets (perhaps even just keeping cash in fixed deposits). The closer you get to retiring, the more you should focus on contributions, and the less you should be concerned about chasing higher returns.
Higher Contributions Often Mean Less Stressful Investment Choices
The drawback to safe investments, such as Singapore Savings Bonds and fixed deposits, is that they provide low returns. If you don’t contribute much to retirement, you cannot just rely on these safe methods. Their rate of return is too low to cope with inflation, and also provide a decent replacement income upon retirement.
If you contribute a more substantial amount however, there is a greater chance that these simple, stress-free investments will suffice. The more disciplined you are at saving, the less risk you’ll need to take when building a retirement fund.
If you are risk-averse, or get anxious at the thought of high return investments, then perhaps you should look at making bigger contributions instead.