Yes why can't we just leave all that money in the bank? You and I probably know what inflation is, however how many people who are disciplined with savings seriously believe that you need to do more with the money in the bank? If every month you have surplus in the bank, your bank balance is growing and your expenses seems fairly manageable, would you feel an urge to commit to taking risks with investment or signing a long term commitment with endowments?
In this article, let me show you why.
If you aren't saving 50% of your income or more, pure savings mathematically cannot help you retire
To give a simple example, let's say John earns $6000. He starts work at 25. He spends $3000 on his monthly household expenses. He works for 40 years. He saves $3000/month. He saves $36,000 a year and $1,440,000 over 40 years. He intends to retire at 65 and sees himself living till 85 (potentially longer). Assuming his expenses stays at $3000 to maintain his lifestyle, he needs $36,000 a year. Factoring in a 3% inflation, he needs $117,433.36 per year 40 years later. If he lives till 85, he needs $2,348,667. His pure savings is thus insufficient. Of course this is a simple example, John shouldn't be earning the same pay for 40 years. He probably started out with lesser and would earn more at the end of his retirement. But you get the idea. How many of us even save 50% of our wages? If it's lesser, it'll be worse.
So here's a common favourite assumption people like to make. Expenses will definitely drop during retirement. Most commitments are paid up and you spend less on dolling yourself up for work. Okay, let's assume John's expenses drop by half. John now needs $1500 per month for his expenses for 20 years. That amounts to $18,000 a year, translating to a future value of $58,716/year at 65 and $1,174,320 in total for 20 years. *Do note this example is overly simplified. Things will continue to get more expensive from age 65-85 even when you have no income! Now if John's expenses does drop by half, he can retire purely by saving 50% of his income. However, if I factor in inflation adjusted figures assuming accurately that 65-85 the cost of living continues to go up, now John needs an average of $1,647,655.36 to fund his original $1500/month expenses for his retirement. In this case, saving 50% of his income is insufficient again.
So how? Financial instruments are supposed to help your money sitting idle to work harder and potentially meet/beat inflation. Whether you invest or choose lower risk instruments to preserve wealth, it boils down to your comfort level. However, the instruments chosen should minimally meet inflation. If it doesn't, maybe you shouldn't pick that instrument.
Most people cannot tell you how much of their savings in the bank goes to retirement planning
Do you know how much of your savings is meant for your retirement? Chances are, you keep your money in the bank for multiple purposes like your emergencies, your holidays, your luxury wants, your house renovations, etc and what's left would be for your retirement. Looking at the math shown above, if you need an estimated minimum of 50% of income (unless you earn a super high income with fairly low expenses) for retirement, spending the money in the bank for other purposes will leave you with a bigger shortfall.
This is a common problem. Retirement happens at the end stage of our life cycle so most people prioritize it last. In order to ensure there's no oversight in the money you set-aside, people use financial instruments to help you 'lock up' the money. The truth is, people like their money wholly accessible to them regardless whether they are going to spend it or not. That's also the problem. Our itchy fingers might just take the money to buy something we like because we are feeling 'rich' and conveniently forget about our old age needs. Financial instruments exists partially to instill discipline. There's this saying out of sight, out of mind. By automating your retirement savings, you can be sure that this money will be there during your retirement years. If you choose to put your funds in investment, there will always be an element of risk. Hence, it's my suggestion to have a mix of guaranteed and non guaranteed solutions to strike a good balance.
You can't beat inflation by putting the money in the bank
Finally, the most common sense reason of them all, keeping the money in the bank erodes your spending power. I once shared this on my Facebook Page.
This is my favourite peanut dumpling with bean curd & soya milk. It used to cost $3.60 and now it costs $4.20. I can either choose to pay more for the dessert in order to enjoy it, or opt to buy beancurd with soya milk (no dumplings) at $2.20. Partially because I find $4.20 too rich an indulgence for a snack and also because I'm used to paying $3.60, I chose to buy the $2.20 version and add my own dumplings which I bought from NTUC. Of course, I need to do a lot more work in exchange for the lower cost.
If you keep all your money in the bank, can you see yourself doing more work to lower the cost for EVERY aspect of your life 20-40 years from now?
Financial instruments act as wealth preservation and wealth accumulation tools. By putting your idle money into such instruments, you are merely ensuring that you can still afford to pay for the same indulgence you don't think twice paying for when you have income. I can tell you, there are many times I was tempted to pay $4.20 just for convenience, after all, it's not like nobody cannot afford $4.20. The thing is, will I think the same way when I am retired?
Summary
Financial instruments help our money work harder in order for us to retire comfortably as purely saving in the bank is insufficient unless we earn a lot and spend very little.
Our own disciplined saving habit usually only ensures that we have money for emergencies and additional wants. We tend to prioritize retirement last because it's the end stage of our life cycle.
Financial instruments instills discipline in us to make sure we set aside money for our retirement.
Inflation is real and will affect us whether we preserve our spending power or not. Financial instruments simply ensures that we can maintain our lifestyle 20-40 years later when we are retired.
We should only put our idle funds in financial instruments that potentially can meet or beat inflation.
Should you decide to get started on your retirement planning journey, do speak with a trusted advisor. Alternatively, you can drop me a message if you would like me to help you with it.
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Disclaimer: The content created are based on my personal opinions and may not be representative to everyone or any organisation. If you have any doubts or queries pertaining to insurance or investment, please seek professional advice from a trusted adviser in an official setting. You may also reach out to me if you do not have a present adviser using the message box under 'Let's Talk'.
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