Essential Elements of Wealth Plan
While many tend to approach wealth management on an adhoc basis (i.e. implementing products off the shelf), I think there are merits to incorporate financial instruments at a more holistic portfolio basis. In this article, I provide an overview of what I believe are essential elements of a comprehensive wealth plan. Insurance or risk management tends to form the foundation of a wealth management plan, however, for the purpose of this article I will not include discussions on insurance and protection planning.
One key element of your wealth plan are your emergency funds. These are generally liquid assets which you can activate on short notice in the event of emergencies (e.g. unforeseen expenditure, retrenchment, etc). One trend I notice around emergency funds is that most people either have too little or too much emergency funds. I recommend around 3 to 6 months of income to be kept liquid as emergency funds. The risk of having too little emergency funds is straightforward, i.e. you may not have the funds when you need it. Many tend to under-appreciate the risk of having too much emergency funds, which is the purchasing power of your funds being eroded by inflation at a rate of around 2 to 3% per annum.
Annuities are lower risk instruments providing a life time monthly or annual payout. Annuities are an important part of the portfolio to guard against longevity risks and partially buffer against market volatility during your retirement years. I tend to use annuities as the base of a retirement portfolio to provide partial or fully guaranteed income during retirement. The good news is most Singaporeans already have an annuity in the form of CPF Life as part of their retirement portfolio. Depending on individual circumstances and preferences, some may choose to add private annuities to supplement the payouts from CPF Life.
LOW RISK ACCUMULATION
Lower risk accumulation generally serves two main purpose in a portfolio. The first is to buffer a drop in the portfolio should the market experience high volatility (e.g. in the event of a recession), the second is to provide consistent cash flow to fund essential expenses when markets are down. To fulfil the two objectives above, lower risk accumulation instruments should have lower correlation to market movements and offer more stability in terms of valuations and returns. Examples of lower risk accumulation instruments include bonds, endowments, annuities, etc.
HIGHER RISK ACCUMULATION
Higher risk accumulation instruments are the return optimisers in your portfolio. They should broadly give you better returns and outperform inflation in the long term. Examples of higher risk accumulation instruments include equities, exchange traded funds (ETFs) , real estate investment trusts (REITs), etc. Most of the higher risk accumulation instruments are directly correlated to the financial markets. Their returns are generally more volatile and dependent on market performance at a specific time. While it may seem tempting to overweight higher risk instruments for more risk aggressive investors, investors should factor in their comfort level with high market volatility in event of a financial crisis as the portfolio scales above six figures.
Tax optimisation strategies should be an integral part of your wealth management plan if your income is above $100,000 per annum. There are a few simple tax optimisation strategies you can employ, including utilising the Supplementary Retirement Scheme (SRS) and Retirement Sum Topping Up Scheme (RSTU). I wrote about both the above schemes in an earlier article. You can read more about both schemes here.
Most people tend to see their wealth distribution plan as an afterthought. The plan tends to be whatever is not spent will be passed on to the next generation. What they do not realise is a well thought through distribution plan can substantially increase the effectiveness of the estate being distributed while avoiding many of the common unintended pitfalls in estate distribution.
I hope the above gives you a broad idea of how you can structure your wealth plan. If you like to have a more in depth discussion of how you can better manage and plan your finances, do get in touch for a chat.